Italy may find November is the cruellest month
Many things must fall into place smoothly in November, including the formation of a new Italian government with an acceptable finance minister and the reconvening of parliament. Immediately after, comes the annual budget which must be examined by the European Commission before the end of the year. This process, always difficult, is likely to be even more difficult this year due to a wider budget deficit and increased borrowing. With 245 billion euros ($238 billion) in government bonds to refinance next year and 230 billion euros in 2024, there is very little room for error.
So far, newly elected Prime Minister Giorgia Meloni, leader of the Brothers of Italy party and leader of a right-wing coalition, has been careful not to cause too many budget waves since winning the September 25 election. Unfortunately, everything is not so simple since Fabio Panetta, member of the board of directors of the European Central Bank, who would have been his first choice for the post of finance minister, declined the opportunity. Italian President Sergio Mattarella has few executive powers, but he must approve ministerial appointments; the finance minister is the key role, and a technocrat has generally been preferred to calm nerves in Brussels over fiscal discipline.
Moody’s Investors Service made clear in its Oct. 5 review of Italy’s Baa3 rating, already with a negative outlook, that the new coalition’s attempts to overhaul the national recovery and resilience plan brokered by the outgoing prime minister Mario Draghi would increase the risks of a downgrade. . That would leave Italy with an undesirable rating.
Italian 10-year yields have more than quadrupled this year, reaching 4.7%. But it is on shorter-dated debt that the pain of the ECB’s key interest rate hike is really being felt. Three-year yields, which were negative at the start of the year, are now above 3.5%; borrowing costs are over 4% for terms of five years and longer. The 10-year yield spread between Italian and German debt widened to more than 250 basis points.
Unfortunately, Italy may find itself politically most vulnerable just as the ECB’s ammunition to defend peripheral Eurozone bond markets is at its lowest. The central bank is counting on recycling maturing debt acquired under its pandemic emergency purchase program from wealthier countries such as Germany, France and the Netherlands to finance new purchases of Italian, Spanish, Portuguese and Greek debt.
In June and July, the ECB bought around €8.5 billion worth of Italian bonds, but the pace slowed considerably towards the end of the summer. So, in theory, there is still ammunition. The central bank is understandably coy about how much firepower it is keeping in reserve, but a worrying time looms in the final months of this year and the start of 2023. Following a major French buyout in October, there are few maturities available from donors. countries available to support Italian debt or other peripheral countries. Austria has 10.5 billion euros due at the end of November and there is a German repayment of 14 billion euros in mid-December, then the pace slows down until March. Italy itself has large takeovers, but it brings little benefit.
Additionally, the proportion of these maturing bonds that is held under the main asset purchase program, which is not eligible for cross-market reinvestment, is unclear. According to Bloomberg Intelligence strategist Huw Worthington, on average less than a quarter of the ECB’s holdings are in the pandemic QE facility. Capacity could therefore be insufficient to counter the resale of peripheral debt. Of course, there is also the ECB’s new anti-fragmentation weapon, the Transmission Protection Instrument, to rely on. But details on how and when it might be used remain extremely scarce.
With a quarter of a trillion euros in debt to refinance next year, it will cost Italy an additional 11 billion euros a year if yields stay this high, as the average interest rate on its debt will triple. It’s hard to know where and when Italy’s debt sustainability tipping point is – but it’s surely getting closer to the edge of the cliff.
More from Bloomberg Opinion:
• Meloni’s Ship of State Heads for Troubled Waters: Rachel Sanderson
• The Bank of England should make a U-turn on the sale of Gilt: Marcus Ashworth
• Bond markets near painful inflection point: Mark Gilbert
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Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was Chief Market Strategist for Haitong Securities in London.
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