Italy faces credit rating tests with more hope than fear

By Sara Rossi

MILAN (Reuters) - Italy faces a round of credit rating agency reviews over the next few weeks with realistic hopes of an upgrade thanks to a rapidly narrowing fiscal deficit, analysts said, although concerns about Rome's huge debt pile remain.

Markets have long seen Italy's debt, proportionally the second largest in the euro zone, and its chronically slow growth as key weaknesses, demanding higher premiums to hold Italian bonds than those of any other country in the bloc.

The government's 1% growth target this year looks hard to achieve, Economy Minister Giancarlo Giorgetti said this month, while debt is seen climbing from 134.8% of gross domestic product last year to 137.8% in 2026, before gradually declining.

But there have also been positive developments on the public finance front which analysts said are sure to be considered by S&P Global, Fitch, Moody's, DBRS and Scope Ratings, who will in turn review Italy from Friday until Nov. 29.

The government last month sharply cut its deficit to GDP targets for this year and next and said the fiscal gap will fall below the European Union's 3% limit in 2026.

Then, in budget plans for the next three years presented on Wednesday, Giorgetti announced 5% annual curbs in central government spending, the kind of move usually welcomed by rating agencies in their assessments.

This time around, the agencies are considered more likely to upgrade Rome's outlook than directly raise the rating.

"We see scope for a mild upward rating trajectory ahead. A change to a 'positive' outlook is more likely as a first step, and S&P Global perhaps the most likely to move first," Citi wrote in a report last week.

S&P Global and Fitch kick off the round of autumn reviews on Friday. Both have Italy on a 'BBB' rating, with a stable outlook.

SPREADS NARROW

The premium investors pay to hold Italian government bonds over top-rated German ones narrowed on Thursday to below 120 basis points, the lowest level since end-2021.

Positive news from any of the ratings agencies "could increase appetite for Italian bonds, especially among Asian investors, and trigger further tightening of the Italy-Germany spread," said Fabio Balboni, senior economist at HSBC.

Italy, along with France and five other countries, was placed under the European Union's Excessive Deficit Procedure in June, and analysts noted that the deficit reduction path set out by Rome is far more ambitious than Paris's.

"France's deficit will only return below the 3% EU limit in 2029, much later than the 2026 target set by the Italian government," said Franziska Palmas, senior Europe economist at Capital Economics.

The gap between German and French benchmark 10-yr bonds stood at around 75 basis points on Thursday, close to a peak hit in June after French President Emmanuel Macron called snap elections, sparking market turmoil.

Fitch revised France's outlook to "negative" from "stable" last week, citing increased risks regarding politics and fiscal policy.

(Reporting by Sara Rossi, editing by Gavin Jones and Jan Harvey)