LONDON: German government bond futures rose on Thursday after Moody's cut Spain's credit rating to just one notch above "junk" and ahead of an Italian debt auction which could prove tricky as the debt crisis deepens.
Moody's slashed Spain three notches to Baa3, its lowest investment grade rating, and said it could lower the rating further within the next three months. The agency said the newly approved euro zone plan to help Spain's banks will increase the country's debt burden.
If Spain is cut to junk then some index-tracking investors would be forced to sell the country's bonds, adding to upwards pressure on yields which pushes financing costs higher.
September Bund futures were 26 ticks higher at 141.97, after two days of heavy selling, with German 10-year yields half a basis point lower at 1.49 percent.
"The ratings cut is more bad news for Spain and it increases the chance of a full bailout going forward," a trader said.
Italy will test market sentiment with the sale of up to 4.5 billion euros of bonds. Demand is expected to be sufficient to place the paper but borrowing costs are set to rise sharply after yields at a one-year bill sale on Wednesday rose close to 4 percent.
"We are fast approaching the point where both Spain and Italy may have to be removed from the market," said Gary Jenkins, director of Swordfish Research.
Italian BTP futures were 49 ticks lower at 96.73.
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