U.K., Italy Lead Moody’s Concerns in Europe Over Next Five Years

(Bloomberg) -- Britain and Italy top the list of European concerns for Moody's Investors Service in the coming half-decade as they grapple with the fallout from the coronavirus pandemic and economic headwinds.

Moody's, which downgraded the U.K. to Aa3 in October, sees the Brexit trade deal reached late in 2020 as little different from a no-deal scenario over the medium-term, according to Sarah Carlson, senior vice president for sovereign risk at the ratings company. For Italy -- ranked just one notch above junk status -- questions abound over whether the government will make the most of its “once-in-a-generation” opportunity in spending European Union recovery funds, she said.

These factors are difficult to disentangle from the pandemic, with both nations locking down their economies as they grapple with some of the highest death tolls from the coronavirus. That's led government borrowing to soar amid the steepest recessions in decades.

“It used to be in the U.K. when debt levels would rise, they would be brought down again in a very prompt fashion,” Carlson said in an interview. “Right now the U.K. effectively has no fiscal policy anchor.”

So far central bank support is providing a backstop to both nations, enabling them to finance borrowing at close to all-time low costs. Benchmark 10-year U.K. yields were at 0.35% Tuesday, while similar-dated Italian rates traded at 0.64%, near last month's record of 0.50%.

Yet Italy's debt load, seen above 158% of gross domestic product in 2021, is more of a concern compared to peers such as France and Germany. The nation will likely re-enter a recession by the end of the first quarter, according to Bloomberg Intelligence.

Italy is also facing a renewed bout of political instability after the ruling coalition collapsed over how the EU funds would be spent. The nation is the biggest beneficiary from the program on a nominal basis.

“The two big credit challenges are structurally low growth and high debt,” said Carlson. “For a country that has for years faced structural growth challenges, seeing how Italy performs here is really quite important. The political climate is something that can influence that.”

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