HispanicBusiness

Frankfurt (dpa) - Italy passed a key market test Friday with the country successfully raising 5.25 billion euros (6.41 billion dollars) in a bond auction, despite the rating agency Moody's downgrading Italy's government bond rating.

The US-based agency said it was retaining a negative outlook for the eurozone third biggest economy as a result of poor data and political risks - at the same time warning about the threat posed of contagion from other heavily indebted European states, notably Spain and Greece.

"The risk of a Greek exit from the euro has risen, the Spanish banking system will experience greater credit losses than anticipated, and Spain's own funding challenges are greater than previously recognized," Moody's said. It downgraded Italy's bond rating from A3 to Baa2.

But European markets appeared to take the Moody's downgrade in their stride with bourses across the currency bloc gaining ground Friday, helped along by Italy's meeting the goal of cash it sought to raise in a new bond auction.

Investors even lay aside their doubts about the euro with the common currency managing to nudge up in during the morning trading session. But it remained close to two-year lows of just over 1.22 dollars.

Shares in Italy initially fell 0.8 per cent following the downgrade, which also resulted in the yield on ten-year Italian bonds climbing about 12 basis points above 6 per cent ahead of the auction.

The downgrade risked driving up the borrowing costs Italy faces on bond markets.

Still, the Italian Treasury placed a new three-year bond incurring a 4.65-per-cent yield, which was down from six-month high of 5.3 per cent, which Rome had to pay in June.

Analysts said this in part reflects the moves by European leaders to shore up the Spanish banking sector.

By the end of the morning session in Milan, shares were up just 0.16 per cent.

Rome's short-term rating, applied to debts on a shorter timescale than government bonds, was unchanged at Prime-2, Moody's said.

Since the last rating five months ago, the risk had increased of "a further sharp increase in its funding costs or the loss of market access" for Italy, the agency said.

This was due to increasingly fragile market confidence and the risks of contagion.

"Italy's near-term economic outlook has deteriorated, as manifest in both weaker growth and higher unemployment, which creates risk of failure to meet fiscal consolidation targets," Moody's said.

"Failure to meet fiscal targets in turn could weaken market confidence further, raising the risk of a sudden stop in market funding," it said

Despite praising Italian Prime Minister Mario Monti's commitment to press forward with tough reforms, Moody's said its "negative outlook reflects our view that risks to implementing these reforms remain substantial."

Moody's also expressed doubts whether the eurozone bailout funds were large enough to accommodate the Italian economy in the event of renewed pressure on the country's bond markets.

But Italy was doing better than some eurozone economies in other regards, it said, including the maintenance of a primary surplus, a large and diverse economy capable of absorbing economic shocks, and progress on structural reforms.

Rome on Thursday raised 7.5 billion euros (9.2 billion dollars) on the financial markets with one-year papers at 2.697 per cent, down from 3.972 per cent on June 13.