Investors virtually ignored last weekend’s bail-out for Spain’s banks and continued to sell off Spanish debt this week. Yields on ten-year Spanish paper hit a new euro-era record above 6.8% as prices slumped. Cyprus was deemed increasingly likely to need a bail-out due to its heavy exposure to the Greek meltdown (as we noted in last week’s issue). Greek elections this Sunday could lead to a chaotic Greek exit from the euro if the new government turns its back on Europe’s rescue package and thus runs out of cash.
But by mid-week all this was a sideshow. Italy was back in the market’s cross-hairs as investors fretted that it would also need rescuing. Ten-year yields rose above 6%, an implied interest rate that is unsustainable over the long term. Rome had to pay an interest-rate of almost 4% on one-year paper – up from 2.34% a month ago.
What the commentators said
Compared to Spain, Italy has much lower private debt, a smaller budget deficit, and largely stable banks that didn’t gorge on property loans. The reason the waves are lapping at the door is the “eye-popping” overall public debt pile of 120% of GDP, which is becoming increasingly expensive to finance, said Fxpro.com. Italy’s growth has lagged behind the rest of the eurozone for over a decade, making it all the more difficult to reduce this suffocating debt load.
The problem now is that prime minister Mario Monti’s structural reform agenda, which promised to boost growth, has stalled. After an initial victory with pension reform, he “relented soon after on labour market reforms”, which have become bogged down in parliament anyway. “He also back-tracked” on service sector liberalisation. And his political leeway is only going to dwindle as elections next spring draw closer.
To make matters worse, harsh austerity – the government will tighten by 3.5% of GDP this year – is causing the usual vicious circle. Output is sliding faster than debt can be paid off, so that debt as a proportion of GDP is rising. “We expect that Italy will have to request help”, said Citigroup. However, there is not enough money in Europe’s rescue funds, so Italy is ‘too big to fail’.
Markets remain rattled that Europe “still has no unified response to the debt crisis”, said Ambrose Evans-Pritchard in The Daily Telegraph. Nor does it have a quick one, if deliberations about banking unions and fiscal unions, steps that Germany won’t countenance in a hurry, are anything to go by. In these circumstances, said Allister Heath in City AM, if Italy also “succumbs, then all bets would truly be off”.