Rating upgrades highlight Europe’s improved position

With a week currently feeling like a long time in geopolitics, the European sovereign crisis at the beginning of the last decade feels even more like a distant memory. The road to recovery for Europe’s periphery economies has been long and windy, but post-Covid it has been surprisingly smooth. This is not a coincidence, since it is in part the fruit of the significant structural progress these countries have made since the sovereign crisis. Just as an example, economic growth in Spain and Portugal has been among the strongest we have seen in developed markets since 2020, and in the last couple of weeks we have seen further credit rating upgrades awarded to Italy and Greece as their fundamentals continue to improve.

On Friday, S&P upgraded Italy’s credit rating to BBB+ from BBB. The number that has haunted Italy’s finances in recent years is its high debt-to-GDP ratio. This was a concern for markets when it hit 154% back in 2020, but it has since steadily declined to the current level of 135%. S&P noted that this is still  “elevated” relative to other developed markets, but the agency expects it to stabilise from 2028 onwards, not least because it expects Italy to return to a primary surplus in the next couple of years. It was this trend, along with other improving economic fundamentals such as historically low unemployment below 6% and the current account now being back in a surplus, that was the main driver of the upgrade decision. Interestingly, the expected increase in fiscal stimulus from Germany, which is Italy’s largest export market, also acted as a tailwind for the ratings upgrade, as did the fact that Giorgia Meloni’s administration has been the longest serving government in Italy’s recent history.

The only country in the Eurozone with a higher debt-to-GDP ratio than Italy is Greece, and again the improvement in this metric was central to S&P’s upgrade of the country to BBB from BBB- on Friday. The ratio is now at 159%, having been above 200% just three years ago, and the Greek government has a very ambitious target of 115% in its medium-term plans. It is this improved “fiscal discipline”, again along with robust GDP growth (2.3% in 2024) and healthy labour market trends, that has led Greece firmly into investment grade territory, having been rated CCC a decade ago.

It is worth noting that these upgrades do perhaps come at a strange time considering the elevated macro uncertainty stemming from US tariffs, which is prompting downward revisions to global growth forecasts. Indeed, in its upgrade report for Italy S&P referenced its assumption that the US tariff rate on Italian goods remains at 10% for the foreseeable future, an assumption that is far from guaranteed at present. That aside, the trend in rating upgrades more generally speaks to the good work that has been done by the Europe’s periphery economies in recent years.

For us, one positive impact of the recent sovereign upgrades is the potential for similar moves on the banks based within these territories. Italian national champions Intesa Sanpaolo and UniCredit, for example, which have seen their fundamentals improve drastically over the last decade but have been capped by the sovereign rating, also enjoyed one-notch upgrades last week. Given these rating upgrades apply across the capital stack, notably for these banks it means their Tier 2 bonds moving into the investment grade index, which should lead to a demand tailwind for them in the short term.

And so, while the global world order currently appears to be on shaky ground, these recent rating upgrades offer another example that the Eurozone is generally in a strong and much improved position for dealing with external shocks.