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Moody's warns it may cut Italy's debt rating; Greek bailout talks advance

June 17, 2011 |  1:42 pm

The dreaded fear of contagion in Europe’s government-debt crisis flared on Friday after Moody’s Investors Service put Italy’s bond ratings on review for possible downgrade.

Moody’s move came after hopes rose early Friday that euro zone countries might yet cobble together another bailout for Greece without forcing private bondholders to participate in a debt restructuring.

Germany appeared to drop its insistence that Greece's private bondholders share some of the pain. The European Central Bank and other euro-zone authorities have argued that forcing a debt restructuring on investors could be considered a default by Greece, potentially fueling a new credit crisis in Europe.

Italyflag The immediate concern is for European banks that would be weakened by losses on the Greek bonds they own. But the bigger risk is that a Greek default could trigger more dumping of bonds of other struggling euro-zone countries, including Portugal and Ireland.

The threat of a cut in Italy’s bond ratings also reminded investors that the continent’s debt woes extend beyond its relatively small nations. Greece is just the 10th largest euro-zone economy, while Italy ranks fourth in size.

Moody’s said its decision to reevaluate Italy’s rating, currently Aa2, was spurred by economic growth challenges, uncertainty about the country’s ability to lower its debt burden and “risks posed by changing funding conditions for European sovereigns with high levels of debt” -- a reference to the broader debt crisis in Europe, which has forced many countries to pay higher interest rates on their bonds in recent months.

The annualized yield on two-year Italian bonds has risen from 2.30% in mid-March to 2.99% now. Still, that’s a fraction of the 28.8% yield the market is demanding on two-year Greek bonds, and well below the 13.03% yield that two-year Portuguese bonds pay.

Moody’s announcement came after European markets had closed. Stocks were mostly higher across Europe on guarded optimism about a Greek bailout deal.

The euro rallied to $1.43 in New York from $1.42 on Thursday, and held onto its gains despite Moody’s move.

Greece's parliament still must approve an extremely unpopular austerity program. Protests against further austerity spending cuts stoked rioting in Athens this week.

-- Tom Petruno

Image: The Italian flag