Euro zone overrates ability to curb contagion - Moody's

By Ana Nicolaci da Costa and Marc Jones

LONDON (Reuters) - The euro zone's awkward handling of Cyprus's bailout puts extra pressure on the bloc's downgrade-threatened sovereign ratings and shows policymakers overestimate their ability to contain the crisis, credit agency Moody's said.

Cyprus clinched a 10 billion euro bailout from international lenders this week, but its terms have broken with past taboos by seizing up to 40 percent of the cash held in the island's banks by wealthy individuals and firms.

Market analysts fear that could set a dangerous precedent for future rescue efforts and make the region more prone to bank runs if depositors in other debt-strained countries think their money is no longer safe.

"Policymakers appear very confident that market conditions are benign enough and that they have the tools to avoid contagion to other peripheral economies and their banking systems," Bart Oosterveld, managing director of sovereign risk at Moody's, told Reuters.

"We think that that confidence may well be misplaced."

While Spain and Italy have so far proven resilient, analysts fear the chaos in Cyprus has increased the risk of contagion if investors think the same will happen if other countries ever seek financial help.

The European Central Bank has sought to quash suggestions the tactics used in Cyprus could become a bailout blueprint.

But comments on Monday from Jeroen Dijsselbloem, the head of the Eurogroup of finance ministers, that it could be a model for dealing with future euro zone banking crises has left market concerns difficult to erase.

Oosterveld, speaking alongside two of the firm's other sovereign analysts, declined to comment on whether Italy and Spain, which both have negative outlooks on their respective Baa2 and Baa3 ratings, were particularly vulnerable to a downgrade after the events in Cyprus.

But they did say Cyprus remained at risk for a "prolonged period" of default and even of exiting the euro zone.

LOOKING AT BERSANI

For Italy, the difficult euro zone backdrop and its own political troubles, were a headwind to its growth outlook and could have a future impact on its rating, said Dietmar Hornung, who oversees Italy for Moody's.

"The Cyprus situation and its impact on euro area sovereigns is negative and Italy is no exception," Hornung said. Social cohesion as well as the health of the country's banks would also play an important role.

Italy has been in political deadlock since inconclusive elections last month. Pier Luigi Bersani, whose alliance won the largest share of the vote in February but fell short of a parliamentary majority, is meeting officials from rival parties to try to muster support to form a government.

"In the short term we are obviously looking at Bersani's attempt to form a government and the implication for the credit profile," Hornung said.

LESS PAIN IN SPAIN?

The analysts were not so concerned about Spain, noting it had been easily selling bonds since the ECB said it would buy the debt of struggling countries, and that its fiscal situation was improving.

"While there was a lot of market talk about Spain being the first to apply to the OMT (ECB bond buying) programme, in the end, they didn't need to and continued to enjoy market access," Oosterveld said.

Asked whether this meant it would change the outlook on Spain's rating to stable from negative, he said:

"Like with any other euro area country, the negative outlook of Spain's Baa3 rating is driven by a combination of country specific and euro area wide factors... we are comfortable with our current ratings and outlooks."

The picture in France was also unclear. Moody's cut the rating of the euro zone's number two economy by one notch last year and has said a further cut could come if its outlook continues to worsen.

"They are certainly moving in the right direction," said Hornung. "...That being said, both in terms of economic strength and government financial strength, the turnaround has not been achieved yet."

(Editing by John Stonestreet)