Last updated: May 24, 2011 9:37 am

Moody’s restokes euro contagion fears

Moody’s, the US rating agency, warned on Tuesday that a Greek sovereign default would could spark contagion as it would have major implications for the eurozone, possibly leading to downgrades across the continent that would deepen the debt crisis.

It said adverse credit rating implications would not be limited to Greece, but to other stressed European sovereigns, Greek banks and other financial institutions and corporates in the currency zone.

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The impact on Greek credit ratings would depend on the extent of the default, but would most likely cause the country’s credit rating to fall seven notches from B1 to Ca, or eight notches to C, although not to default.

It added that the Greek banking sector would require recapitalising to offset banks’ losses on Greek government bonds, and continued liquidity support from the European Central Bank.

The warning came after the euro and the Spanish and Italian bond markets came under pressure on Monday amid growing investor fears that the problems of Greece are hitting the bigger economies of Europe’s single currency.

The euro remained near record lows against the Swiss franc and two-month lows against the dollar.

Spain’s cost of borrowing for 10-year debt eased slightly, however, after a successful auction of €2.3bn in short-term T-bills on Tuesday. Bid to cover for both the three and six month issues was more than 5 times, and while the yield payed on the three month bill was slightly higher than at the last auction, the six month yield ticked lower.

After some heavy falls for equity markets in the previous session, most indices were calmer on Tuesday. Stocks in Italy – the biggest fallers down 3.3 per cent on Monday – rallied 0.3 per cent.

But investors remained on edge over Europe’s debt issue.

John Wraith, fixed income strategist at BofA Merrill Lynch, said contagion was spreading to the bigger eurozone economies. “It is like a group of climbers roped together. As Greece slips, it pulls down other countries such as Spain and Italy.”

Spanish bonds were hit by the poor performance of the ruling Socialists in regional elections. Miguel Angel Fernández Ordóñez, the governor of the Bank of Spain, said the country should not accept the high cost of financing sovereign debt and must press ahead with its economic reforms.

The extra cost Spain pays above Germany to borrow over 10 years has jumped to 2.48 percentage points.

Italian bonds came under early pressure as investors reacted to a warning late on Friday night from Standard & Poor’s over the country’s credit rating. S&P said it had cut the outlook on Italy’s A-plus rating to negative because of worries over the economy.

Tensions eased on Italy, however, after Silvio Berlusconi’s centre-right government said it was preparing a package of cuts and revenue raising measures for the next two years with the aim of balancing Italy’s budget by 2014.

Delays to the Greek reform programme and fears the International Monetary Fund might refuse to provide the country with the next instalment of its bail-out loans has unsettled financial markets and increased worries Athens will default on its debts.

Fears of contagion have been the main cause of a 6 per cent fall in the euro against the dollar since the start of the month, while the extra cost Spain and Italy have to pay over Germany to borrow has jumped sharply since the middle of April.

A London-based fixed income trader said: “The idea of [Spanish] decoupling is dead. We are seeing quite a lot of selling of Spanish government bonds… It is feeling quite miserable in the market again.”

However, other strategists said contagion was limited on Monday as both the Spanish and Italian bond markets, although down on the day, recovered after suffering sharp initial losses.

The biggest falls were in the Greek, Irish and Portuguese bond markets because of rising fears that all three countries would end up having to restructure their debt.

Greek bond yields also eased a touch after Athens announced plans to privatise a number of companies in an effort to tackle its debt problems.

Additional reporting by Victor Mallet and Miles Johnson in Madrid, Joshua Chaffin in Brussels, Kerin Hope in Athens, Guy Dinmore in Rome and Rachel Sanderson in Milan

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