Being reasonably experienced in European bonds I can just about recall the time when, just over 25 years ago, Standard & Poor’s awarded Italy its first Foreign Currency Long-Term Debt rating. Back then, Italian debt was denominated in Lira and withholding tax was payable on the coupons by investors. The gross yield on a 10-year bond was nearer 12.5%. Interestingly the post-tax differential between Italian domestic debt and German domestic debt was around 300 basis points, much higher than the 150 basis points of today. The spread however is not strictly comparable with current markets as it was in the pre-Euro period and therefore incorporated an element of currency risk.
The credit rating awarded was AA+. Over the last 25 years, Standard & Poor’s has downgraded Italy eight times, culminating in a rating of BBB- in 2014. Yields have been volatile but currently are close to 25-year lows at around 1.75%, despite this trend of continual downgrades; the interest rate and inflation environment have had a greater influence than the credit rating.
Last Friday, the trend changed and for the first time ever, Standard & Poor’s upgraded its rating for Italian debt. Only one notch to BBB with a stable outlook. But an upgrade nonetheless.
Reasons cited were the improved economic outlook, an improvement in government finances and the resolution of some of the problems in the banking sector. Further upgrades could occur if progress is maintained, which we think is reasonably likely.
A word of caution however; we may have to wait another 25 years before a rating of AA+ is to occur.