High spreads and interest rates: is Italy’s public finances weakening?

Status: 02/08/2022 15:04

Draghi’s government is leaving, debts remain, interest rates are rising and the risk premium for Italian government bonds is rising sharply. How stable is the Italian national budget? Analysis.

Author: Jörg Seisselberg, ARD Studio in Rome

Vincenzo Visco has seen many storms in Italian fiscal policy. The 80-year-old economist was a university professor and finance minister under Romano Prodi – and is now concerned about developments in the markets after Mario Draghi’s fall: “There is a strong political component to the current situation. New elections and a possible victory for the radical right are troubling the markets. This is reflected in the current spread development ”.

The spread is the difference between the interest rate on German and Italian government bonds. In the financial markets, this is an important benchmark in terms of whether Italy’s public finances are healthy or not. At the beginning of the week, the spread was 2.25 percentage points, about 2.5 times higher than in mid-February. For many, this is an alarm signal.

Because at the start of the year, Dutch major bank ING continued to argue that a spread of more than two percentage points would put Italy in a financial spin due to high public debt – with all the associated risks to the euro.

“There are no major problems at the moment”

On the other hand, Italian analyst and financial author Maurizio Mazziero does not see the red warning level reached: “There are no major problems at the moment. They may arise if the spread increases above three percentage points. ‘ The danger of going over the three percent threshold is that you are entering the upper range of what we have already seen in the history of the Italian spread.

Namely, during the 2011 financial crisis: At that time, says Mazziero, the Italian spread was at five percentage points. Currently, the level is more than half lower. In principle, however, the analyst is also concerned about the development of Italian government bonds.

Political uncertainty is driving the returns

Since the Draghi government was in crisis, the ten-year bond yield has exceeded three percent. The last time interest rates were higher almost four years ago, in October 2018. The driving force of the current development is the political uncertainty in Italy and the change in the interest rate policy of the European Central Bank.

This new interest rate policy seems to be dangerous for Italian public finances, explains Mazziero: “More spending on interest rates contributes to an increase in debt. The debt then has to be financed. ” To do this, an increasing amount of government bonds would have to be issued. Which in turn increases debt through higher interest payments, according to the analyst, “You can fall into a vicious cycle that is very difficult to get out of.”

The ECB holds 30 percent of Italy’s public debt

However, it also emphasizes that the current risk to Italian public finances is much lower than during the 2011 financial crisis. Firstly, because around a third of Italian debt has been bought by the European Central Bank and is therefore not exposed to market speculation.

Mazziero also sees the new Transmission Protection Instrument (TPI), which is already threatened by lawsuits in Germany, as a way to discipline governments that are willing to spend: “We don’t know much yet about the rules by which this instrument is. But it is clear that the instrument will only be activated if fiscal policy is balanced, there are no macroeconomic imbalances and, above all, the fiscal policy is stability-oriented ”.

Inflation benefits the debtor Italy

Inflation is currently in the hands of the government in Rome. Like any price increase, it benefits debtors. Italy’s mountain of debt, currently around 2.75 trillion, is melting at least a little these days.

And even more importantly for public finances: Italy’s economy is growing. While Germany stagnated at zero in the second quarter, Italy saw an increase of 1.0 percent. Former Finance Minister Visco fears that if the right-wing parties take over the government, this development will collapse: “If they come to power and raise pensions and lower taxes as announced, it will be painful. Very painful”.

High spreads and interest rates – Italy’s finances weaken after Draghi’s departure?

Jörg Seisselberg, ARD Rome, August 2, 2022 3:04 PM

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