By: Dr. Mike Campbell

Italy has the third largest economy in the Eurozone behind Germany and France. It also has a very significant public debt burden and has seen many years of torpid economic growth. Growing concern that Italy would follow Greece, Ireland and Portugal in needing financial support from the IMF/EU led (ironically) to yields on Italian ten-year bonds climbing above the 7% level. The crisis led to the resignation of the Italian Prime Minister, Silvio Berlusconi and the installation of an unelected, technocrat cabinet led by Mario Monti.

Italy has pushed through further austerity measures and the technocrat government has survived confidence votes. This has seen the heat go out of the bond yield crisis, although yields remain at uncomfortably high levels.

Fitch’s rating agency has warned that a downgrade of Italy’s current A+ status could be imminent. This would signal the agency’s belief that the risk associated with Italian sovereign debt had risen. In turn, it could push up the cost of borrowing of funds Italy needs to meet its existing obligations.

The head of Fitch's head of global sovereign ratings, David Riley, opined that the fate of the Euro “will be decided at the gates of Rome”. Whilst that is certainly poetic, it is also probably fanciful. Although Italy is far more crucial to the European currency project than Greece and its relatively unimportant debt, we are not yet standing on the brink. Mr Riley suggested that an Italian downgrade was on the cards because of the lack of a clear plan to deal with the Euro crisis (at an integrated level) and because of the Italian public debt which stands at something like €1.9 trillion.

Mr Riley told reporters in London the logic underlying the Italian decision; which is expected at the end of the month: "One thing which would also help Italy, which is outside of its immediate control, is to take out the liquidity crisis premium, which basically means you need to have a... firewall. At the moment we don't have that and that's a serious concern with regard to Italy. It's one of the reasons why we have Italy on watch negative, it's one of the reasons why when we conclude that review, there is a significant chance that that rating will fall."

So there you have it.