Italy eyes first rating upgrade from Moody's in 23 years

By Alessia Pe

MILAN (Reuters) -Moody's review of Italy on Friday may yield the first rating upgrade for almost a quarter of a century, analysts say, reflecting growing confidence in the public finances of the euro zone's third largest economy.

The agency lifted Italy's outlook in May this year to positive from stable while keeping the rating at 'Baa3', the lowest rung of investment grade, citing a stronger-than-expected fiscal performance and a steadier political backdrop.

Since then Giorgia Meloni's government has cut its 2025 budget deficit goal to 3% of gross domestic product, respecting the European Union's limit a year ahead of schedule helped by stronger tax revenues and lower debt servicing costs.

RATING UNCHANGED SINCE 2018

"Italy's fiscal outturns keep surprising positively, supported by the unwinding of a massive fiscal stimulus, job-rich and tax-rich GDP growth and EU-financed fiscal support," Citi analysts wrote in a weekly report.

They added that "positive fundamentals have not yet been captured in the rating, which remains close to 2015-16 levels."

Moody's has not improved Italy's rating since May 2002, when it passed from Aa3 to Aa2, and the rating has not changed since a downgrade in October 2018.

Positive action from the agency would round off a string of ratings boosts for Italy in the autumn round of reviews, with Fitch upgrading it to BBB+, DBRS lifting it to A (low), and Scope improving the outlook on its BBB+ to positive from stable.

S&P Global was the only agency to make no change, confirming the sovereign at 'BBB+' with a stable outlook, having hiked the rating just six months earlier.

Italian government bonds have rallied strongly: the gap between 10-year BTPs over safe-haven German Bunds - a key gauge of the extra return investors demand to hold Italian debt – has narrowed by around about 40 basis points since early September to around 75 basis points, near a 15-year low.

Analysts at UniCredit said a potential upgrade on Friday would mark "another step in the constructive trend that has characterised the overall assessment of Italy's creditworthiness," noting that among major rating agencies Moody's remains the most cautious.

BBVA assigned a 60% probability to an upgrade, arguing that Moody's decision not to downgrade France but to merely move its outlook to negative in October "might be interpreted as a signal supporting a positive action on Italy."

STAGNANT ECONOMY

Still, challenges remain. Italy's aging population and high debt burden weigh on long-term sustainability, while global trade tensions add uncertainty to its already chronically weak economic growth.

Gross domestic product stagnated in the third quarter after shrinking by 0.1% in the second, and the government last month cut its forecast for full-year growth to just 0.5%, after 0.7% expansion last year.

Yet for now, ratings agencies and markets are focused on the positives and rewarding Rome for its fiscal discipline and political stability, with Meloni's government still popular after three years in office.

(Additional reporting Valentina Consiglio, editing by Gavin Jones)