Not a good night for Europe. Italy had breached “containable” levels of yields on its government debt even with the ECB buying. Italian bonds reached an all time euro-high of 7.41% for the 10-year (+69bp). The spread over German bunds hit a new all-time high of 565bp.
Although it has been obvious for some time that there is no credible plan for Italy, last night’s thumping seems to have been triggered by LCH.Clearnet’s move to increase the margin needed to trade Italian bonds . The European CDS continue to climb and spreads now appear to show that the contagion is heading to the core via France, which I have pointed out previously was always a threat.
As I stated yesterday the politics of Greece and Italy are mostly irrelevant to the outcome at this point. Greece may have been able to be saved by debt write-offs, wage deflation and then a slow re-build of the economy, but Italy is simply too large for that approach. Italy requires a credible supra-European plan which means austerity for itself along with either reverse austerity from Germany and/or a far quicker move towards fiscal unity. These could occur in the long term, but Italy simply doesn’t have the time.
Paul Krugman recently wrote a piece (h/t Leigh) demonstrating quite clearly what the true issues of Europe are, yet to this point I haven’t seen any evidence that anyone is even acknowledging it let alone addressing it. The one-sided “demand squeeze” approach pushed on the periphery via austerity is failing to address the issue and at the same time is causing a slow-down across Europe.
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The euro problem can then be defined a finding a way (1) to finance these imbalances in the short run (2) end the imbalances over the medium run.
It’s also worth noting that we’re not talking about imbalances that have been going on forever.The internal imbalances of Europe are a recent development, coinciding with and almost surely caused in large part by the creation of the euro itself (GIPS is Greece, Italy, Portugal, Spain):
As Krugman states, what is needed is a way to finance the imbalances in the short term. With the ECB seemingly unwilling, at least at this time, to provide lender of last resort for the euro, no concrete plan to introduce some form of fiscal transfer mechanism, and the EFSF already looking like a failure, there simply doesn’t appear to be a credible path available for Italy to make the transition.
German and French officials have discussed plans for a radical overhaul of the European Union that would involve establishing a more integrated and potentially smaller euro zone, EU sources say.
French President Nicolas Sarkozy gave some flavor of his thinking during an address to students in the eastern French city of Strasbourg on Tuesday, when he said a two-speed Europe — the euro zone moving ahead more rapidly than all 27 countries in the EU — was the only model for the future.
The discussions among senior policymakers in Paris, Berlin and Brussels go further, raising the possibility of one or more countries leaving the euro zone, while the remaining core pushes on toward deeper economic integration, including on tax and fiscal policy.
Deeper integration is certainly what is required, but the rumour of countries leaving the Eurozone isn’t going to help Italy or Greece in the short-term and that is what matters at this time.
In Italy Berlusconi still looks to be on the way out…slowly”
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Prime Minister Silvio Berlusconi’s offer to resign leaves Italy struggling to produce a new regime stable enough to implement painful austerity measures in a country that has averaged almost a government a year since World War II.
Berlusconi said today that he favored early elections and that Angelino Alfano, head of his People of Liberty party, might be the candidate. Berlusconi last night said he’d step down as soon as parliament passed cost-cutting steps pledged to European Union allies in a bid to convince investors Italy can curb record borrowing costs. Parliament is due to vote on the measures in the coming weeks.
Italian lawmakers have yet to receive the austerity legislation that parliament must pass before Prime Minister Silvio Berlusconi resigns, Senate Finance Committee Chairman Mario Baldassarri said.
The amendment containing the proposed measures “was supposed to arrive last Thursday” in parliament, and then “it was supposed to arrive Friday,” Baldassarri, who left the premier’s party last year to join the opposition, said in an interview today in Rome. “Monday, they let us know they would wait for the vote in the Chamber of Deputies,” which took place yesterday.
The Senate Budget Committee suspended a session scheduled this morning to examine the legislation after failing to receive the text. The board reconvened in the afternoon, only to break up again after it had still not received the document.
Greek Prime Minister George Papandreou has officially stepped down. But a top-level meeting of Greek political leaders has been postponed, with leaders yet to name the new prime minister.
Critical powersharing talks in Greece collapsed on Wednesday evening, with a new prime minister yet to be named. Political leaders will enter a fourth day of negotiations with the country’s president on Thursday.
Earlier Prime Minister George Papandreou officially stepped down to make way for a new coalition government, but he too failed to name his successor in his resignation speech.
“I would like to wish every success to the new prime minister and of course the new government,” Papandreou said in an address to the nation on state TV. “I will stand by them and I will support them with all my strength.”
Greece would implement an EU bailout decision and do all it can to stay in the euro, he added.
I am now watching for stories from or about exposure to the French banking system as this is likely to be next area of contagion.
