Moody’s: European credit quality decline slowing, but no upturn expected

The decline of credit quality in western Europe slowed over the first quarter of 2007 due to strong economic growth especially in the financial sector, but an upturn in the credit cycle is not in sight this year, according to a report by Moody’s Investors Service.

The upgrade to downgrade ratio rose to 0.84 over the quarter, from a low of 0.40 in the third quarter of 2006. This improvement was due to a rapid rebound from the February market blip, sustained appetite for risk, and strong corporate cash flows.

Marcus Schüler, head of integrated credit marketing at Deutsche Bank in London, was surprised by the report’s findings. He said: “Recently falling default rates have reached zero in speculative grade issuance, so people in the market are saying credit quality is very good.”

The outlook for the rest of the year is less positive, according to the report. Higher interest rates and inflation point to financial market uncertainty, and Moody's expects default rates to rise over the rest of 2007, with downgrades outnumbering upgrades until the third quarter, and little improvement in sight for credit quality for the next eight to 12 months.