Italy Comes Back Into Focus

Includes: EU, EWI, FXE
by: Acting Man

Berlusconi's Party Pulls Out of Ruling Coalition

Silvio Berlusconi's party has finally made good on its threat to pull out of the ruling coalition in the wake of the Cavaliere's many legal problems finally catching up with him. As we noted in our article in early August, Berlusconi has lined up his daughter to succeed him as the leader of the "People of Liberty" party he currently heads. In all likelihood, the party's political calculus is that it will continue to lose electoral support if it remains in a coalition with leftist prime minister Letta and pushes through even more unpopular austerity measures in concert with him. It was far easier to hide behind Mario Monti's 'technocratic" government, which was formed to deal with what was clearly an emergency at the time.

Of course, the fact that the PL has now pulled out its ministers from the coalition government could easily bring said emergency back. According to a report at Reuters, which extensively quotes labor minister Enrico Giovannini, there is allegedly "no chance" that Italy will miss its fiscal targets, regardless of which parties form the new government. We are far less certain of this. There are also a few other interesting tidbits in this report, which we have highlighted below:

“Italy could face pressure from international partners if the current political crisis persists and reverberates through the euro zone, Labour Minister Enrico Giovannini said on Sunday.

Speaking a day after Silvio Berlusconi pulled his ministers out of the cabinet, Giovannini said the move — which pulls the rug from under Prime Minister Enrico Letta's government and lurches the country into another political crisis — is likely to cause some instability on financial markets on Monday. The volatility need not last if there is a quick resolution to the crisis, Giovannini told Reuters in an interview.

He said there was no prospect of Italy following Greece or Portugal and being placed under special oversight by the European Commission, International Monetary Fund and European Central Bank "troika".

But he said Italy, which has only recently regained its footing with financial markets and its European Union partners, was walking a fine line on the international stage. "If instability were to persist and affect the euro zone, then international authorities could put much stronger pressure on national authorities," said Giovannini. 'that's why this crisis is the last thing we needed."

Berlusconi asked for and obtained the resignation of five ministers of his centre-right party on Saturday, plunging the government into crisis only five months after it came to power. Letta and President Giorgio Napolitano, are expected to seek a new parliamentary majority to back a cabinet and avoid elections.

Though Berlusconi says he wants to go to a vote, much of the political establishment – and in particular, Napolitano – want to avoid elections, just seven months after the last ones, which produced deadlock.

Saturday's resignations followed a meeting when the cabinet, failed to approve some 3 billion euros of tax hikes and spending cuts aimed mainly at keeping Italy's budget deficit under 3 percent of national output this year.

According to the latest government figures, Italy is expected to marginally overstep the European Union's 3 percent deficit ceiling this year.

Giovannini said whatever cabinet might emerge from the crisis would to bring the deficit back in line. 'there is no risk the 3 percent will be violated in the next few years. We are absolutely on safe ground," he said.

Because the Friday decree was not approved, however, Italy's sales tax will now rise to 22 percent from 21 percent — in accordance with a previous law passed by the previous technocrat government of Mario Monti.

That could be an extra burden on Italians, who are only just emerging from a crippling recession. Though there are signs that business and consumer confidence is improving, unemployment among young people excluding students is close to 40 percent and the number of people in absolute poverty has risen to 5 million.

Giovannini said that the upcoming sales tax increase would not necessarily lead to a hike in prices. However, he said that if companies do not pass the tax increase onto consumers, the impact to their bottom line was likely to translate into fewer investments in the next few months.”

'this could mean that the growth rate might be lower than the 1 percent estimated (by the government) for 2014," said the minister, who was brought in by Letta from his previous post at the helm of Italy's statistics agency.

Renewed political crisis means Italy will again postpone crucial structural reforms aimed at reducing its 2 trillion-euro-debt and laying the foundations for a healthier economy. Friday's thwarted decree also now puts at risk shorter-term measures, including some 330 million euros in extra funds for Italy's job support scheme, 35 million euros to extend a food stamp program until the end of the year.

'the end of recession was supposed to give people a new outlook. Political instability could threaten not so much the economic recovery we expect before year-end, rather a pick-up in growth in 2014," the minister said. "And this could dampen people's hope in the future."

(emphasis added)

What is noteworthy about the above is that once again, "austerity" takes the form of "austerity for everyone except the government". In other words nothing is being done except that taxes are hiked even further. Note that "crucial structural reforms" have once again been postponed. We are still wondering why these reforms were not enacted during Mario Monti's 'technocratic" era. At the time it would have been much easier to actually enact politically unpopular, but necessary labor market and other economic reforms. Instead the unimaginative bureaucrat Monti also did nothing but increase taxes, while pushing for more ECB intervention at the countless euro debt crisis summits that took place at the time.

Markets Still Relatively Little Concerned

As we have pointed out previously, there are actually very few signs that the growth of Italy's public debt is being brought under control. That would require far more spending cuts rather than tax increases, as the latter weaken the private sector's ability to grow wealth. The most optimistic estimates see Italy's debt-to-GDP ratio at 132% by year-end. Italy's public debt is already clocking in at well over € 2 trillion, the third extant largest public debt mountain in the world in absolute terms.

A recent article at Zerohedge confirms something we have pointed out frequently in these pages, namely that Italy's commercial banks have truly gorged themselves on the debt issued by their sovereign in the past two years, playing the carry trade as a result of what was likely a tit-for-tat sub rosa agreement between banks, governments and the ECB.

What essentially happened was that Italy's government "guaranteed" many of the assets held by Italy's banks in order to make them eligible for the ECB's LTROs. The banks in turn used the liquidity provided by the ECB to buy up Italian government debt, so that they now hold nearly € 400 billion of it – a fourfold increase since 2008 and a doubling since late 2011, when the sovereign debt crisis was at its height. They may well come to rue this decision, judging from the charts of Italian government bond yields:

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Italy's 10 year government bond yield rises to a new three month high. If it breaks above 4.8%, a new uptrend will be in place.

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Italy's 2 year yield has produced what looks like a bottoming formation. A rise above 2.6% will constitute a breakout and likely be the start a new intermediate term uptrend.

The Italian stock market has remained remarkably strong of late, with the newest political crisis only putting a small dent into the recent rise:

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The MIB has declined a little bit from its recent highs, but seems largely unperturbed by the political turmoil so far.

We can conclude that market participants are continuing to extend the benefit of the doubt to Italy's political class, i.e., they believe the assertion that reform will stay on course no matter who will end up ruling the roost. These calculations could turn out to be mistaken in the event of a new election being called. In that case, much will depend on the performance of Beppe Grillo's 5 Star Movement, which could become the arbiter of policy even if it doesn't join a coalition government, simply as it may become able to sabotage decisions it doesn't agree with by withholding its consent.

It is a good bet that there is a limit to the extent of political uncertainty the markets are willing to countenance without demurring. In fact, given that the technical resistance points for Italian yields are so close to current levels, it presumably won't take much for the currently still relatively tranquil situation to evolve into something altogether more unpleasant.

Charts by: BigCharts