European stocks rallied yesterday as investors brushed aside news of a credit rating downgrade for Italy and grim growth revisions from the International Monetary Fund to focus on an upcoming meeting of the US Federal Reserve.
The euro clawed back earlier losses against the dollar after the overnight downgrade of Italian sovereign debt by ratings agency Standard & Poor’s and as Greece, struggling to avert a default, awaited more talks with auditors from the IMF, European Union and European Central Bank.
Analysts said markets had expected a downgrade for Italy, although from ratings agency Moody’s rather than S&P.
At close, London’s FTSE-100 index of leading shares rose 1.98 per cent to 5,363.71 points and Frankfurt’s DAX climbed 2.88 per cent to 5,571.68 points.
In Paris the CAC-40 see-sawed all day, closing up 1.50 per cent to 2,984.05 points despite shares in Société Générale and BNP Paribas falling sharply after a report that industrial giant Siemens had pulled out cash from a French bank to deposit it more safely at the ECB.
Elsewhere in Europe, Milan rose by 1.91 per cent, Madrid by 1.45 per cent, Lisbon by 1.02 per cent, Amsterdam by 1.79 per cent and Brussels by 1.52 per cent.
In late trade, after briefly dipping below $1.36, the European single currency stood at $1.3697 from $1.3692 late in New York on Monday. The dollar slid to 76.49 yen from 76.59 late on Monday.
“European markets have shrugged off the downgrade of Italy’s sovereign debt by Standard and Poor’s last night as optimism about a successful conclusion to the on-going troika negotiations (in Greece) gains traction,” Michael Hewson of CMC Markets said.
“Markets have also shrugged off significant growth forecasts downgrades by the IMF for the US, Europe and the UK, for 2011 and 2012,” Hewson added.
In its twice-yearly report, the IMF said the global economy was much weaker than believed just months ago, saying activity had “weakened significantly” and warned of a return to recession if leaders in the eurozone and the US failed to fix their economies.
Markets were waiting to see if the Federal Open Market Committee, the key policy body of the US Federal Reserve, takes action to boost the US ailing economy when it meets on Tuesday (yesterday) and today.
“Given the weakness of the incoming economic data, the Fed is now almost certain to do something, but exactly what is still not entirely clear,” Paul Ashworth of Capital Economics said.
“The proposal to lengthen the average duration of the Fed’s asset holdings, dubbed Operation Twist, appears to be the front runner,” he added.
Traders also digested a US government report showing housing starts fell in August, the latest in a string of negative data confirming the housing market collapse.
Standard & Poor’s meanwhile cut its Italian debt rating to “A/A-1” from a “A+/A-1+” grade because of “Italy’s weakening economic growth prospects”.
It added that Italy’s weak governing coalition would “limit the government’s ability to respond decisively” to events.
The downgrade pushed up Italy’s borrowing price on the secondary markets with yields on benchmark 10-year bonds rising to 5.696 per cent from 5.572 per cent on Monday. Safe-haven Germany’s benchmark yields fell to 1.789 per cent from 1.799 per cent.
Greece meanwhile raised €1.625 billion, more than original target of €1.25 billion, in a sale of three-month treasury bills with the borrowing price stable at 4.56 per cent.
Italy’s problems come as Greece was in crisis talks with its EU-IMF creditors for a second day.
Unless Athens can come to an arrangement with auditors to release eight billion euros from its 110-billion-euro rescue package agreed last year, its reserves to pay pensions and wages will run out in October.
The first round of talks on Monday was “productive and substantive,” the finance ministry said in an emailed statement.
Jane Foley at Rabobank said that Greece may be optimistic that talks with creditors “brought them close to an agreement on the steps that Greece needs to take in order to secure the next tranche of its bail-out, but the markets are clearly sceptical”.
“The reality is that even if Greece secures the eight billion euros this will be seen as no more than a sticking plaster on the fears over whether Greece will eventually default,” she said.