ECB rate hike exposes fears for Italy as eurozone’s weakest link

Economists say Italy is the eurozone country most vulnerable to a debt crisis as the European Central Bank raises interest rates and buys fewer bonds in the coming months.

Nine out of 10 economists in a Financial Times poll identified Italy as a eurozone country “most at risk of an uncorrelated sell-off in the government bond market.”

Italy’s right-wing coalition government, in power in October under the prime minister Giorgia Meloni, is trying to follow the path of fiscal integrity. It has budgeted to reduce the country’s fiscal deficit from 5.6% of GDP in 2022 to 4.5% in 2023 and 3% the following year.

But Italy’s public debt remains one of the highest in Europe at more than 145% of gross domestic product. Marco Valli, chief economist at Italian bank UniCredit, said the “higher need to refinance debt” and the “potentially complex” political situation made the country most vulnerable to a sell-off in the bond market. .

Rome’s borrowing costs have risen sharply since the ECB started raising rates last summer. Yields on 10-year notes jumped above 4.6% last week, nearly four times where they were a year ago and 2.1 percentage points higher than comparable yields on German bonds.

Meloni expressed disappointment at the ECB’s willingness to continue raising interest rates despite the risks to growth and financial stability. “It would be helpful if the ECB handled its communications well. . . otherwise it risks creating not panic but volatility in the market that will nullify the efforts that governments are making,” she said at a press conference last week.

Veronika Roharova, head of euro zone economics at Swiss bank Credit Suisse, said the new Italian government had “given investors a few reasons to worry at the moment”. “But concerns could re-emerge as growth slows, interest rates continue to rise and [debt] Release rose again,” she added.

The ECB’s rate-setters have confirmed that they will continue to raise rates by half a point in the first months of this year. Klaas Knot, governor of the Dutch central bank and one of the board’s hawks, told the FT that the central bank only begin “second half” of the rate hike cycle.

However, analysts believe the ECB is overestimating the risks to inflation – and underestimating the prospect of a recession. IMF Managing Director Kristalina Georgieva speak over the weekend that half of the EU will be in recession this year. Four-fifths of 37 economists polled by the FT in December forecast ECB will stop raising rates for the first six months of 2023, and two-thirds predict that they will start cutting rates next year due to weaker growth.

Column chart FT poll results (% of responses) show When will the ECB stop raising interest rates?

On average, they predict that the ECB deposit rate will peak at just under 3%, below what investors are betting on as indicated by the interest rate swap price.

A separate FT poll of over 100 top UK-based economists says that Britain will endure one of the worst recessions and weakest recovery in G7 in 2023.

Central banks around the world have interest rate hike strong to tackle inflation, which has surged to multi-decade highs in many countries, driven by soaring food and energy prices following Russia’s invasion of Ukraine and the end of the pandemic-induced blockade The coronavirus has pushed up the demand for goods and services.

The ECB started raising interest rates more slowly than many Western central banks, but since last summer it has tightened policy at an unprecedented rate, lifting the deposit rate from minus 0.5% 2% in six months.

Column chart FT poll results (% of responses) show how long will the ECB cut rates?

“ECB was too slow [in] Jesper Rangvid, a professor of finance at the Copenhagen Business School, recognizes that inflation is not temporary but accelerating. “However, I still fear that the ECB will not tighten enough because of the trouble this will cause in Italy.”

ECB is about to start shrink Their €5 trillion bond portfolio grew to €15 billion a month since March by only partially replacing maturing securities, adding upward pressure on Italy’s borrowing costs. Ludovic Subran, chief economist at German insurance company Allianz, said the eurozone risks a repeat of the bloc’s 2012 bond market crisis “because of different financial capabilities across countries. without the strong support of the ECB.”

Italian cabinet ministers have criticized the ECB for its aggressive monetary tightening. Defense Minister Guido Crosetto wrote on Twitter that the ECB’s policies “make no sense” while deputy prime minister Matteo Salvini said higher interest rates “will burn through billions of dollars in Italian savings.” .

“The high debt, the growing budget deficit and the need for additional Italian energy support measures,” said Silvia Ardagna, chief Europe economist at UK bank Barclays. . . causing great concern to the market.”

The ECB has unveiled a new bond-buying program, known as the transmission guard, designed to address an unwarranted rise in a country’s borrowing costs. However, more than two-thirds of economists polled by the FT in December said they expect the ECB to never use it.

Mujtaba Rahman, managing director for Europe at consulting firm Eurasia Group, said a deeper recession than expected next year “could leave high-debt, high-debt countries exposed more pressure” and added that this “could provide a softer path for monetary policy”. ECB policy”.

Additional reporting by Amy Kazmin in Rome


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