Italy Causing A Big Trouble To The EU

Forex News

European regulators are concerned that Italy's possible coalition government would harm the Eurozone economy and even lead to crisis in the bloc. As it was reported yesterday, Italy's anti-establishment 5-Star Movement and the far-right League are forming a coalition and basically planning to change the common EU government borrowing and spending system.

EU rules limit government budget deficits to 3% of GDP and debt to 60% of GDP and oblige governments to seek balanced budgets. Italy has a debt of 132% of GDP and slowing growth, thus EU is deeply worried about it. Jan von Gerich (Nordea Chief Strategist) stated: "With the M5S/LN government, the underlying problems of the Italian economy, including low growth, inflexible labor markets, inefficient banking system and public administration will not be tackled, in many cases only worsened", adding: "In short, trust towards Italy is bound to face heavy tests under a M5S/LN government, even if the two parties will not be able to implement their program in full".

Today, yields on benchmark Italian 10-year debt increased 3 bps, marking an almost 3-month maximum. The League is going to ask EU for a debt forgiveness in order to reduce the EU 250 billion debt. EU regulators reject such offer. One senior EU official even said: "It is totally nuts. It doesn't make any difference to Eurostat who holds the debt".

Also, there are concerns that the new government will instead increase the debt. Officials claim: "There is a real danger that the new Italian government could, through its irresponsible economic policies, set the stage for the next euro zone crisis"; "Everybody is worried that Italy is becoming ungovernable, and that populists will drive the country into another deep crisis"; "They have already become more moderate and this will probably continue. And even if it does not, they will be disciplined by other means, like financial markets". On what, the leaders of two parties answer: "The more they insult us, the more they threaten us, the more they blackmail us, the more desire I have to embark on this challenge".

Some officials note that Italy's big public debt was supported by the ECB's asset purchase program. And that puts pressure on ECB to decide whether the tightening is required or not. The officials comment: "A crisis is not likely in the next 12-18 months, but once the ECB starts to tighten, I would get worried"; "An alternative scenario is that the ECB would feel like it couldn't raise rates without provoking a crisis in Italy and therefore monetary policy begins to lose its independence. We economists call this 'fiscal dominance'. Not likely, but still..."