S&P’s recession forecast worse than downgrades – Zangana

S&P’s latest raft of downgrades were largely priced into markets, but more worrying is its forecast of a high chance of a deep recession in the region, said Schroders’ European economist Azad Zangana.

In a conference call on Monday, the ratings agency said it has revised its base scenario of stagnant or zero growth, and is now forecasting a 40% chance of recession in Europe this year. This would represent a 1.5% fall in GDP for 2012, said Zangana.

This latest gloomy prediction follows a mass downgrade of nine eurozone countries last Friday, which saw France and Austria stripped of their AAA-status; Portugal, Malta, and Cyprus downgraded to ‘junk’ status; and Spain and Italy cut by two notches.

Zangana said the market reaction to the downgrade was muted, with the yield on French 10-year debt falling just 2bps yesterday. There was also little movement in Spanish and Italian debt markets and European equity markets as a whole.

“If you compare this to the yield on UK gilts, there has been a 50bps differential between the two since about October, but in the last month it has been closer to 100bps, so the market has already moved to price that potential downgrade in.”

Although there was a more noticeable market reaction in Portugal, with 10-year yields climbing 120bps, it is still a way off November’s high and could be a reflection of one or two sellers moving the market by trading in what is now a very illiquid environment.

“People should focus on the level of these countries’ credit quality, not just the change in rating - most of these countries still have a relatively high credit rating. France was only downgraded by one notch,” he said.

“Markets tend to focus on the direction of movement of the downgrade. S&P has said – with Slovakia and Germany as exceptions – that most countries have a negative outlook on their long-term debt positions, which means they have at least a one in three chance of being downgraded again this year or next year, so there is still that lingering danger.

“But, at least in the short term, none of these major sovereigns will be downgraded, barring any major change in their ability to fund themselves.”