Long hot summer awaits Italy & eurozone

Update: The key question is whether Italy’s populist government will eventually exit from the eurozone & precipitate a financial crisis.

Be wary of Italy’s bond and stock market relief rally following former academic Giuseppe Conte appointment as prime minister of the populist Five Star Movement and the far-Right League coalition.

Markets, for the moment, are becalmed, as at last there is a new government. But Italy’s problems haven’t vanished. The overall philosophy of the government is to spend more and slash taxes. The result will be an increase in Italy’s debt which is already 133 per cent of GDP. Moreover, the government remains eurosceptic and could leave the euro at an unexpected moment.
Giovanni Tria, Italy’s new finance minister is an advocate of full-blown fiscal reflation and printed money, to rescue Italy’s faltering economy. This means that Italy is on a collision course with the European Central Bank, Germany and France.

Late last week, the euro and Italian stocks and bonds staged a brief rally. But with continual uncertainty over Italian politics and Brexit negotiations, investors are likely to shun European markets for the time being.

The yield on 10-year Italian bonds, which had jumped from early May lows of 1.6  to 3.3 per cent, fell slightly. The stock market, which was down by almost 15 per cent from its early May 2018 peak, revived by 6 per cent. The euro is down by 7 per cent from its February peak against the US dollar.

The worry is that the Italian government will decide to exit from the eurozone because the economy has been underperforming. If it were to do so, there would be a financial crisis in Europe and the possibility of an adverse impact in the Americas and Asia.

Economists such as Brendan Brown, London-based head of Economic Research at MUFG Securities and author of Euro Crash, contend that the nation will eventually dump the euro. But that might take time.

Mario Draghi head of the European Central Bank (ECB) and Germany, in particular, have financed the Italian government and struggling Italian banks with large-scale loans. If there is devaluation, German and other eurozone taxpayers would incur large losses.

Roger Bootle, head of Capital Economics, agrees that markets “should not underestimate the power of the euro establishment to find a solution of sorts and to muddle through.”

“But I wouldn’t bank on it,” he contends. “If Italy were to leave the euro, I feel sure that after an initial loss of confidence and doubtless a fair bit of chaos. ”

But it would not be long before the devalued Italian lira would set off an export boom. Domestic demand would surge and the economy would spurt, he adds.

How Italian 10-year government bonds performed in past decade

 

 

Germany, France and the Brussels European Union (EU) establishment fret that Italy’s government debt is already 133 per cent of GDP and including household and non-financial corporate borrowings, the nation’s debt is 263 per cent of GDP.


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Lorenzo Marsili, an Italian political commentator contends that the coalition parties would fight another election as defenders of democracy against the EU establishment. Already polls are indicating that they may further increase their majority.

Eleven per cent of the working people are jobless and the youth unemployment rate is a disturbing 32 per cent.  The populace is deeply disenchanted with income, health and educational inequalities.

An estimated 8.4 million Italians are poverty-stricken, according to national statistics. They fear the hundreds of thousands of Middle Eastern and north African migrants who have entered Italy.

© copyright Neil Behrmann

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