Brexit negotiations are hogging the UK headlines.
With our team-leading Prime Minister strutting her Dancing Queen stuff at the Tory party conference (no comment!), that’s hardly a surprise.
A no-deal divorce remains a possibility. And that’d be expected to deal damaging economic blows both to Britain and also to the rest of the EU.
But while a war of words is being waged across the English Channel, another big battle is being fought at the other end of the Eurozone.
Italy is in a right mess. Indeed, fears are growing that – regardless of what happens with the UK – Italy could splinter the single market all by itself.
So is this likely to happen?
Follow the money
Students of the Italian bond market (no comment on that either) have been warning about trouble for months.
The country is seriously over-borrowed. Italy’s national debt is more than 130% of GDP. And rising. Remember, the UK gets flak for its 85%debt/GDP ratio.
Yields on Italy’s 10-year sovereign bonds closed yesterday at 3.3%. Though slightly down from Tuesday, that’s still up from 1.8% six months ago. In fact it’s back to levels last seen in March 2014.
Meanwhile the gap between Italian and German 10-year bonds, though below 3% again, is still near its widest in more than five years, says Reuters.
Bond yields rise because investors require higher returns as compensation for taking bigger risks. In Italy’s case, lenders to the government have been spooked by a mix of a zombie economy and also disconcerting noises being made by the country’s politicians. And the ‘yield gap’ with German bonds indicates how large a risk premium the markets are now demanding for holding Italian state debt.
The Italian panic started with the general election in March this year.
Now I tend to avoid writing about politicians. In Italy’s case, I’ll be sticking to my own rules, not least because I don’t really understand the country’s politics.
Suffice to say, though, that the coalition government which eventually emerged after all the horse trading isn’t exactly toeing the EU line (Theresa, please take note).
What’s more, it’s further exposing as a complete fallacy the theory spread by the EU’s Brexit negotiators that the rest of the single market speaks with a united voice.
It clearly doesn’t, which is why the whole EU edifice will fall apart one day… err… sorry… I’m digressing.
Back to Italy.
To cut a long story short, Italy’s budget plans have already scared lenders.
So what the latter didn’t want to hear was a comment from Claudio Borghi, economic head of the League party (one of the coalition partners), that most of the country’s problems would be solved by Italy leaving the Eurozone. That would allow Italy to devalue its currency and improve its balance of payments.
Borghi later retracted this statement, while Prime Minister Giuseppe Conte also said that Italy is totally committed to the single currency.
Apparently, “assurances by the politicians that there are no plans to leave the euro have reassured markets,” ING rates strategist Benjamin Schroeder tells Reuters.
Mmm… sounds a bit like a football club’s directors having ‘complete confidence’ in their manager just before they sack him.
Anyway, the whole Italian saga has got traders comparing Italy to Greece, which needed a full-scale bail-out between 2010 and 2015.
Greece mark II?
If Italy did defect, it’d cause complete chaos. Not least because of the country’s huge ‘Target2’ debts to other EU states. In comparison, a no-deal Brexit would be a picnic.
So is an Italy-inspired Eurozone implosion imminent?
EU-sceptic I may be, but I’m not convinced.
The main reason for Italy’s problems isn’t state overspending – despite all the talk, its budget deficit is likely to be around 2% of GDP this year versus the 2009 Greek deficit of more than 15% – but consistently weak economic growth.
“Rather than resulting in a sudden crisis, as has happened in Greece several times, we suspect Italy’s troubles will be more of a slow burn”, says Jack Allen, Senior European Economist at Capital Economics.
Almost two-thirds of Italy’s debt is owned domestically, which contrasts with the 84% of Greek government borrowing that was held by foreign investors. Further, Italian private sector debt at 113% of GDP is lower than the 2009 equivalent ratio in Greece of 121%.
“Unlike Greece’s private sector in the run-up to 2010, Italian firms and households are deleveraging, meaning that economic growth isn’t reliant on ever-increasing debt”, says Allen. “Italy’s external accounts are also less worrying. In 2009, Greece ran a current account deficit of 12.3% of GDP. Last year, Italy had a surplus of 2.9% of GDP. And Italian assets are much less vulnerable to a sell-off sparked by foreign investors”.
Having seen from Greece what can go awry, policymakers have since built up their crisis-fighting toolkit. If they receive a cry for help from Italy, I suspect they’ll do ‘whatever it takes’ to keep the Eurozone intact.
So while I reckon the global bull market in stocks won’t end well, I don’t expect Italy to be the main catalyst in sparking a major sell-off. But I may be wrong.
The problem of a slow burn is that the ongoing lack of growth combined with persistent budget deficits means that Italy’s national debt will continue to rise.
This would put Italy’s government at odds with the European Commission and under more pressure from financial markets, notes Allen. Add in some externally-imposed austerity and Italy might just be tempted to default. And that would get very nasty as lenders everywhere lose money.