Italy shares higher despite Moody's downgrade, EU warnings

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Milan (AFP)

Italian shares were higher early Monday despite Moody's cutting Italy's credit rating on concerns about the populist government's plans to increase public spending, which also face strong EU opposition.

Shortly after the open, the FTSE Mib Index was up 1.82 percent at 19,428 points but it then slipped back to show a gain of 1.49 percent.

Other European markets were also higher, helped by a strong performance overnight in Asia.

London added 0.44 percent, Frankfurt rose 1.0 percent and Paris was up 0.9 percent.

Italian government bonds also rallied sharply, reflecting hopes that Rome may avoid a confrontation with Brussels over the budget.

In early trade, the Italian 10-year government bond yield was at 3.39 percent, down nine points, narrowing the spread with the benchmark German bond to around 2.90 percent, compared with recent levels well above 3.00 percent.

On Friday, Moody's cut Italy's credit rating by a notch, citing concerns over the populist government's plans to increase public spending sharply after years of austerity.

Increased spending will push the budget deficit up to 2.4 percent of annual economic output next year, triple the amount previously forecast and coming close to the EU limit of 3.0 percent.

That in turn will only aggravate Italy's already massive debt mountain, at some 130 percent of GDP, way above the EU 60 percent ceiling and second only to Greece's in Europe.

- 'People's budget' -

The European Commission formally warned Italy last week that its plans for 2019 were a serious concern, sending a letter to Rome to warn that it did not rule out rejecting the entire budget.

Rome is supposed to respond later Monday.

The downgrade from Moody's -- from Baa2 to Baa3 with a stable outlook -- is the latest move by international financial watchdogs sounding the alarm over Italy's economic health.

Moody's cited a "material weakening in Italy's fiscal strength, with the government targeting higher budget deficits for the coming years," as well as debt holding near the current 130 percent of GDP "rather than start trending down as previously expected".

Moody's said "stalling of plans for structural economic and fiscal reforms" also had negative implications for the country's growth outlook and debt.

Aimed at fulfilling electoral promises, Italy's planned spending boost is what the government calls its "people's budget".

It includes a series of pension and tax changes that will cost 37 billion euros ($43 billion), of which 22 billion will be paid for by borrowings, expanding the deficit.

"Following a temporary lift to growth due to the expansionary fiscal policy, the rating agency expects growth to fall back to its trend rate of around one percent," Moody's said.

"Even in the near term, Moody's believes that the fiscal stimulus will provide a more limited boost to growth than the government assumes."

Despite the brickbats from all sides, analysts say Rome is in a relatively good bargaining position given the eurozone's ongoing difficulties with Brexit.

"Italy is headed for a showdown with Brussels and I am not sure they have much to lose," Manulife equities head David Hussey told AFP.

"Given how damaging Brexit is to the EU project, a loss of Italy would be devastating and to be avoided at all costs -- hence I think (that) Italy's hand is quite strong."