By: Dr. Mike Campbell

Ratings agency Standard and Poor’s has added fresh fuel to the Eurozone sovereign debt inferno by deciding to downgrade Italian debt from A+ to A. The job of a ratings agency is to provide a reliable indication to investors of the likelihood of a default on a bond issued by a nation or a corporation. The most secure investment grade bonds are rated AAA and the least secure are known as “junk” bonds. Junk status does not imply that a bond issue will go into default (the vast majority do not), just that the risk of it happening is (in the view of the ratings agency) significantly higher than for a AAA vehicle. The point of this is that investors are compensated in direct proportion to the level of perceived risk

As a consequence of the downgrade, Italy will have to offer better returns on her bonds in order to raise the money they need, pushing up the cost of borrowing and servicing existing obligations. Ironically, of course, this makes the risk of a default significantly higher and a vicious circle can be formed. It will do nothing to calm market jitters about the Euro and is likely to exert downwards pressure on the currency against other major currencies, pushing up the cost of imports to the Eurozone and making Eurozone exports more competitive in export markets – not an untogether unhappy situation in a global slowdown since it enhances Eurozone competitiveness.

S & P argued that Italy’s outlook was negative and voiced doubts that the nation would be able to cut state spending and put its finances on a firm footing in the face of poor growth prospects – despite having passes an austerity budget recently.