The bond markets have woken up to the enormity of what is happening in a country that cannot be easily crushed into submission “à la Grecque”, and that is big enough to destroy monetary union.
By Ambrose Evans Pritchard and cross-posted from The Daily Telegraph
The warnings are coming fast and thick. Fitch Ratings has issued a red alert, deeming Italy’s insurgent government a threat to market stability and sovereign solvency. The conservative leader in the European Parliament, Manfred Weber, said Italians are “playing with fire” as anti-euro Lega nationalists and the alt-Left Five Star Movement join forces to smash the euro austerity regime – and to deport 500,000 illegal immigrants. “This could provoke another eurozone crisis,” he said.
France’s finance minister warns of a “Greek-like” disaster if the new government goes ahead with plans for a flat tax (15% and 20%), a monthly €780 basic income for the poor, a reversal of pension reform and a VAT rise, and a “minibot” parallel currency that subverts the monetary control of the European Central Bank.
Citigroup estimates that these measures will cost 6% of GDP, pushing the budget deficit towards double digits. The Lega-Grillini rebels aim to overthrow the new banking and bail-in rules, and halt the privatisation of Monte dei Paschi di Siena. They will ignore EU state aid rules for Alitalia and the steel industry. It is a total revolt.
The bond markets have woken up to the enormity of what is happening in a country that cannot be easily crushed into submission “à la Grecque”, and that is big enough to destroy monetary union. Risk spreads on Italian 10-year debt have jumped 65 basis points to 189 over the last three weeks. The worry has begun spreading to Spanish and Portuguese debt, a belated recognition that a euro rupture in Italy plausibly could not be contained.
“Nobody has anything to fear from our economic policies,” said Lega strongman, Matteo Salvini, who prides himself on nonchalant defiance of market theatrics. Soaring growth will bring down the debt ratio though the magic of the denominator effect – he said – with help from the Laffer Curve.
The drama in the bond markets is still symbolic at this stage. Italy has ‘prefunded’ much of its borrowing requirement for this year. The European Central Bank is still mopping up much of Italy’s debt issuance through quantitative easing. The problem arises at the end of the year when the ECB turns off the QE spigot.
At that moment, Italy will no longer have a lender of last resort standing behind it. The country will be nakedly exposed to market forces again. A rescue will be available only if the country activates a formal bail-out (ESM-OMT) under draconian conditions, requiring a vote in the German Bundestag and Dutch Tweede Kamer.
There is zero possibility that the Lega and ‘Grillini’ would accept the terms. They would start to activate the parallel currency and set in motion a withdrawal from monetary union, restoring full sovereign control over the Bank of Italy and the Italian commercial banking system…
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