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SandP Downgrade of Italy Prompts ECB Bond Buying

Release Date: 
Tuesday, September 20, 2011

Standard and Poor's downgraded Italy's credit rating on Monday, sending Italian interest rates sharply higher and adding to concern that Europe's debt crisis will raise borrowing costs for countries in the region. In response, the European Central Bank (ECB) stepped in on Tuesday to purchase Italian bonds, helping to steady bond prices and push down interest rates in an attempt to stabilize the economy.

S&P said Italy's economic growth prospects were weakening and planned government reforms would not materially improve the economy. The ratings agency expects Italian real GDP to expand by 0.7% on average each year through 2014, down from the 1.3% growth S&P forecast in May. Industrial data suggest Italian GDP may even contract in the third quarter, said Deutsche Bank economist Marco Stringa.

Analysts at Barclays Capital said the negative outlook was a surprise and the downgrade came earlier than expected. The downgrade is worse than an anticipated downgrade from Moody's Investors Service because S&P's credit rating for Italy was already the lowest of the three major credit-rating companies.

The Italian downgrade may be a harbinger of expanding problems within the euro-zone, said Barclays Capital global macro strategists. The move shows that "contagion risks remain elevated" and that the "market's skepticism extends beyond Italy and now questions the survival of the euro area itself," they said.

"Continued concerns over euro-zone sovereign debt are likely to drive gold higher before policy makers are forced to take more effective action," Bjarne Schieldrop, Oslo-based chief commodity analyst at SEB AB, wrote in a report. "Under current circumstances, a long position in gold is highly recommended."

"There is scope for gold to rally as Europe's problems cannot be settled overnight and Italy's rating downgrade is an example of this," said Zhang Qian, an analyst at Haitong Futures Co., China's largest brokerage by registered capital.

According to a Bloomberg survey at the London Bullion Market Association's annual conference in Montreal, the price of gold will rise to $2,038 per ounce before Dec. 31. Next year, gold prices could hit $2,268, according to the survey average. "This is largely a crisis of confidence, and gold is a safe haven," Rujan Panjwani, the president of Edelweiss Financial Services Ltd., said in an interview at the conference.

(Sources: "ECB Moves to Support Italy," Wall Street Journal, September 20, 2011; "Gold Prices to Top $2,000 This Year on ‘Confidence Crisis,' Survey Shows," Bloomberg, September 20, 2011; "Gold Advances as European Debt-Crisis Concern Stokes Demand From Investors," Bloomberg, September 20, 2011; "PRECIOUS-Gold rises after Italy downgrade unsettles," Reuters, September 20, 2011)

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