Greek bailout could worsen EU debt crisis, warns Moody's

The Greek bailout has increased, rather than decreased, the danger that Europe's debt crisis could spread to Spain and Italy, Moody's warned yesterday as it significantly cut Greece's credit rating and said a default appeared inevitable.

Although the credit ratings agency stopped short of naming Spain and Italy, Moody's was referring to them when it said that for some "non-Aaa sovereigns with high debt burdens or large budget deficits... the negatives will far outweigh the positives and weigh on ratings in the future".

Moody's said that by agreeing to write down the value of their Greek government bonds by 21 per cent, as part of last week's bailout, a precedent had been set that left investors open to further "haircuts" on the sovereign debt of other countries, in the likely event that one or more of Europe's other struggling countries will need additional rescue packages.

The agency's warning came amid mounting concerns about US Treasuries that could potentially eclipse the European debt crisis. Treasury 30-year yields continued to edge up as Republicans and Democrats failed to reach a deal to increase America's debt ceiling, which the world's biggest economy needs if it is to avoid default.

Gary Jenkins, the head of fixed income at Evolution Securities, said: "Moody's is clearly talking about Spain and Italy, and this is hugely significant. The whole idea of last week's bailout was to try to stop the contagion. But in reality the debt problems are now more likely to get worse than better in the medium term.

"If Spain and Italy get downgraded, it will accelerate the loss of confidence in those countries, there will be a sell-off of bonds and its bond yields will rise, meaning it is more expensive to borrow," Mr Jenkins added.

David Buik, of broker BGC Partners, said: "It's already very difficult to sell five-year and 10-year Spanish and Italian bonds and if they come under even more duress it will be absolutely impossible."

Moody's expects that, in the case of previous bailout recipients Ireland and Portugal, last week's developments will be "credit neutral", since the deal with Greece will also see them paying less interest on their bailout borrowings.

This offsets the dangers posed by the "haircut precedent", Moody's said. The agency also expects the ratings of the six Aaa-rated eurozone countries such as Germany and Austria to be unaffected by the Greek deal.

However, those countries that are highly indebted, but which haven't had any of their borrowing costs reduced as part of the Greek deal, are now more likely to see their ratings reduced, Moody's said. Moody's cut Greece's debt rating to Ca on Monday, putting it just one notch below default.

"The EU programme implies that the probability of a distressed exchange, and hence a default, on Greek bonds is virtually 100 per cent. [Greece's] debt will still be in excess of 100 per cent of GDP for many years and it will still face very significant implementation risks to fiscal and economic reform," the agency said.

The €159bn (£140bn) financing package will see Europe and the International Monetary Fund providing €109bn, while investors will contribute €50bn through a debt exchange that will see them writing down the value of their bonds by 21 per cent.

Mounting concerns about worsening debt problems in Spain and Italy pushed up the price of their governments' bonds. The 10-year yield spread between low-risk German Bunds and high-risk Italian government debt increased by 20 basis points to 280.

Investor boost for Ireland

* Ireland sold a €1.1bn ($1.6bn) stake in Bank of Ireland to a group of unidentified investors to keep the country's largest bank out of state hands and provide a rare boost to a battered sector and bruised economy.

The government had been widely expected to take control of Bank of Ireland, the last domestic lender outside of state ownership, after it agreed to underwrite a rights issue, the results of which are due this morning.

However, after the sale and rights issue, the government will now own a maximum 32 per cent in the bank while new investors will hold between 14 and 37 per cent, the finance ministry said.

"It has been recited far and wide that it is impossible for Ireland to get money on the markets," the country's finance minister, Michael Noonan, said.

"Now we have significant private sector investors prepared to put money into Bank of Ireland and that's a strong signal internationally."

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