Italian banks were under pressure on Wednesday as credit markets reacted to a downgrade of the sovereign by S&P.

The ratings agency cut Italy's standing by one notch, to BBB late on Tuesday, citing the contracting domestic economy, sky-high debt and a lack of competitiveness. None of this, of course, came as a surprise to the markets - Italy's economy was lagging behind the rest of Europe well before the Great Recession, and it has been one of the world's most indebted economies for many years.

Thus, a modest move in Italy's sovereign CDS spreads was to be expected. They were trading at 271bps on Wednesday, just 3bps wider than the previous day and more than 100bps tighter than the recent peak on June 24th. S&P's move brings it into line with Moody's (Baa2), and the market already prices Italy as a BB credit, according to Markit's implied ratings.

The reaction in Italian banks, though, was more significant. Unicredit widened by 18bps to 358bps, while Intesa Sanpaolo's 336bps level was 17bps wider on the day. S&P's criteria suggests that both Unicredit and Intesa will have their BBB+ ratings cut by one notch - banks in the eurozone cannot have higher ratings than the sovereign, according to the agency.

The market appears to be anticipating the downgrades in the near future. Italian corporates also widened on the ratings cut, though the moves were unexceptional in magnitude.

Elsewhere, the downgrade had little impact, as it was overshadowed by weak Chinese trade data. Both exports and imports came in well below expectations, indicating that growth is slowing faster than previously thought. It is possible that the figures were distorted by misreporting of exports to Hong Kong in previous months.

Nonetheless, the latest trade numbers show that second-quarter GDP data next Monday will probably see a second consecutive slowdown in the growth rate. Investors looking for a silver lining might suggest that the poor figures will pressure the central bank into relaxing monetary policy.

The Markit iTraxx Europe traded 2.5bps wider at 109bps, while the Markit iTraxx Crossover was 8.25bps wider at 440bps. Sentiment tomorrow will be shaped by the reaction to the latest Fed minutes and Ben Bernanke's speech to the National Bureau of Economic Research, both due after today's European close.

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