This
is what I said a day or so ago
After
Spain, Is Italy the Next Domino to Fall?
The
relief in Rome was short-lived. Italian bonds rallied early on June
11, the first trading day after European finance ministers’ weekend
agreement on a $125 billion bailout for Spanish banks.
11
June, 2012
But
within hours, Italian borrowing costs were creeping back up again,
reflecting persistent market fears that the Continent’s
third-largest economy could be the next to falter. “Contagion into
Italy and other countries is a reality,” Joachim Fels, chief global
economist at Morgan Staley in London, said in a Bloomberg Television
interview as the bond rally petered out.
There
seems to be little Italy can do to innoculate itself. Prime Minister
Mario Monti, appointed last November to succeed Silvio Berlusconi,
has moved decisively to get government finances in order, overhaul
the pension system, and implement regulatory reforms. The country is
on track to bring its budget deficit within 3 percent of GDP this
year. Italian banks are relatively healthy, and unemployment is less
than half the 24 percent in Spain. “Spain’s fundamentals are a
lot direr than Italy’s,” says Nicholas Spiro, managing director
at Spiro Sovereign Strategy in London.
Italy’s
situation is hardly rosy. Its debt burden—120 percent of GDP—is
the highest of any European country except Greece. Its economy slid
into recession during the fourth quarter of 2011 and is expected to
contract 1.7 percent this year. “Monti’s reform agenda is
stalling, unemployment at 10.2 percent is the highest in a decade,
and consumer confidence is the lowest in 15 years,” Marc Chandler,
a currency strategy at Brown Brothers Harriman, wrote in a June 11
research note. “Italy is positioned to be the next lightning rod in
the euro area.”
For
now, yields on Italian debt are at 5.84 percent, less than they were
when Monti took over last year and well below the maximum 8 percent
that officials have said the country can afford.
Maria
Cannata, the head of Italy’s debt agency, said last week that fewer
foreign investors had been participating in debt auctions in recent
months. That means the Italian Treasury is more dependent on local
banks, which have been among the heaviest borrowers from the European
Central Bank in the past three years.
“If Italy has a problem with
accessing the markets because investors lose confidence in the
Italian ability to do the right thing, the ECB will be drawn into the
fire,” says Thomas Mayer, an economic adviser to Deutsche Bank.
Although
the focus is now on Italy, it could soon shift to France. President
François Hollande campaigned on an anti-austerity platform, and his
Socialist Party and its allies took 46.9 percent of the popular vote
in the first round of parliamentary voting on June 10. But Hollande
won’t know until the June 17 second round if he’ll have an
absolute majority. If he doesn’t, he’ll have to form a coalition
with far-left parties, some of which are demanding big increases in
government spending that would undercut Hollande’s promise to
reduce France’s budget deficit.
Investors
will be watching closely, Chandler says. “Hollande’s honeymoon
may last through the final round of the parliament elections. But
then things will become more difficult.”
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