this year’s extraordinary calm on italian bond markets is about to be tested as a possible demotion to junk credit status and europe’s tighter financial conditions threaten a rise in borrowing costs the first test is due within hours when moody’s investors services decides whether italy’s sovereign rating should be lowered from the current baa3 a downgrade would mean moody’s rates italy below romania and in the socalled junk category that includes greece and many emerging markets such as brazil to be clear a moody’s cut would still leave italy with investmentgrade ratings from the two other major agencies a key factor for many funds’ allocation decisions but even if a downgrade is averted other problems beckon the european central bank will soon require euro area banks to start repaying the €500 billion 550 billion in cheap pandemictime loans with italian lenders owing a hefty chunk not is it expected to flinch from further interestrate increases even as it keeps winding back bondbuying stimulus “short term there are some risk events that keeps us prudent on italy” said nicolas forest head of global fixed income at candriam sa “growth has proven resilient but fiscal challenges remain important for italy and need to be closely monitored” still a key measure of risk for italian bonds the yield spread over 10year german notes has been stable this year around 190 basis points well below last year’s highs above 250 basis points that’s due to italy’s recent economic surge and greater fiscal restraint from prime minister giorgia meloni’s rightwing government than investors had expected when it took office last september many also credit the ecb’s anticrisis tool introduced last year it provides for unlimited bondbuying in times of stress read more why europe has a new weapon for bond ‘fragmentation’ quicktake known as the transmission protection instrument tpi the backstop hasn’t yet been deployed but its very presence appears to have helped cap regional borrowing costs without the tpi italygermany spreads would be at 250 to 300 basis points mizuho strategist evelyne gomezliechti reckons “the political backdrop was difficult but spreads didn’t move violently wider” she said what italy needs now is faster economic growth to shrink its debt burden which stands at a staggering 140 of gdp however rome is struggling to allocate and spend hundreds of billions of euros in eu funds crucial to speeding up the economy finally servicing this mammoth debt is becoming costlier the ecb has lifted rates by 375 basis points over the past year and will likely raise them another halfpoint to 375 the more immediate focus is moody’s which said recently italy was the only country liable to losing its investmentgrade rating a downgrade would widen the italygermany yield spread by 50 basis points citigroup inc strategists including jamie searle estimate it would also raise fears of followthrough from other agencies that would risk italy’s membership of bond indexes tracked by funds managing trillions of euros in investment many benchmarks exclude countries rated subinvestment grade by two main agencies “spreads could widen sharply as the market quickly prices the risk of exclusion from bond indices” citi noted more downgrades don’t look imminent however fitch ratings last week affirmed italy at bbb a notch above moody’s and with a stable outlook indicating a change is unlikely for now sp global ratings too has affirmed italy at bbb read more italy survives fitch judgment in boost for meloni before moody’s goldman sachs economist filippo taddei is among those expecting moody’s to hold off a downgrade on friday taddei as well as the citi team even flag the possibility of an outlook upgrade to stable from negative as risks of a growth downturn and energy crisis fade in italy that could see the spreads tighten 20 basis points citi predicted