Posts tagged ‘Italy’
Yesterday, the ECB announced that it was keeping eurozone interest rates on hold at 1%. ECB President Mario Draghi made the remark at the following press conference that “there are tentative signs of stabilization of economic activity at low levels”.
The language was cautious, and Draghi also noted that the economy continued to face serious risks from the debt crisis. But there were another two bright spots of news this morning to suggest that his heavily guarded optimism is justified.
Firstly, Italy sold €4.75bn worth of government bonds, the maximum required, on top of the €12bn of one year financing she raised in the money markets yesterday. The bulk of this – €3bn – came from a reopening of the 6% 2014 at a yield of 4.83%, down from the 5.62% paid on the same bond in December and much lower than the 7.89% paid on issue the month before. This blog has long highlighted the importance of the question of whether or not bond and money markets remain open to Italy (and others). That they are open at levels which have become significantly more affordable is a bonus.
The ECB may be able to take some credit for this. Its programme of 3-year lending to banks, which saw almost half a trillion euros of interest when it began just before Christmas, has given them the incentive and the firepower to increase their bond market exposure substantially.
Be that as it may, it can certainly take credit for today’s second bright spot: the 3.9% increase in eurozone exports which saw November’s seasonally-adjusted trade surplus for the region jump to €6.1bn, a 7½ year high. Eurozone interest rates may only have fallen by 0.5% over the last two months but the 4% fall in the value of the trade weighted euro this brought with it is proving to be as welcome as might have been hoped.
As ever, we should note that there are reasons to be gloomy. After Germany reported a small contraction in output for the fourth quarter, it is certain that European growth stalled into the end of the year and further weakness this quarter could see the eurozone experience a technical recession. Agreement on restructuring Greek debt has yet to be reached, and the ratings companies have already warned of further sovereign downgrades to come. Outside of Europe too, the economic picture remains mixed and markets morose amid a slew of finance sector profit warnings and redundancies.
Nonetheless, predictions of out and out disaster for the eurozone are looking increasingly stretched. It is far from being in the best of health, but reports of its death are an exaggeration.
Europe was the main focus of investor attention this week. For once the latest proposals from the continent’s leaders received a warm reception from markets. The catastrophic failure of the eurozone is not being taken quite so much for granted.
Amid the avalanche of comment on the expansion of the EFSF, the 50% haircut on Greek debt, the financial strength of the zone’s banks and so on, it has been easy to lose sight of what went wrong for Greece, and what might still go wrong for Italy and the others. To assess the risk of full scale catastrophe it is necessary to look in one place only: the bond market.
It was not the banks alone, or the recession alone, or the burden of government debt alone that did for the Greeks. It was the cost of debt. This cannot be emphasised enough. The idea in some quarters that a debt-to-GDP ratio of 100%+ is automatically unsustainable is simply wrong – and not just wrong for giants like Japan, or the US, but for lowly-rated borrowers like Lebanon. Or like Greece, which enjoyed an interest rate on its ten year bonds only 0.27% above that of Germany as recently as 2007. Today that would mean paying 2.5%; at that rate, debt to GDP of 300% would be perfectly affordable.
It was the bond market that broke Greece. The last emergency summit in Europe, remember, was convened back in July to agree a revised bailout for Greece: the continued effective closure of debt markets to the country made the refinancing pathway envisaged under the terms of the original 2010 deal impossible.
At the same time, concerns about contagion through the banking system do not convince. Those expecting lightning to strike in the same place twice need to remind themselves of the scale of banking losses suffered on the back of the subprime crisis: Bloomberg gives a figure of over $2.1trn in writedowns worldwide, with over $1.6trn of capital needing to be raised. For Europe alone the losses were over $730bn. And that crisis took the world largely by surprise. The restructuring of Greek debt, as well as being a much smaller event, is hardly coming out of left field. It is frankly obtuse to expect a comparable degree of systemic dislocation to ensue.
But the bond market is a different matter.
Italy tapped the market for just under €8bn of 3-, 8- and 10-year money this morning, paying rates in the 5-6% range for the privilege. Demand for the new bonds was weak, and this has received a lot of attention, but a rate of 6% is far from disastrous. Italy has about €300bn of debt to refinance next year; at 6% this would cost €18bn in interest per year. If rates were to rise to 10%, however, the cost of servicing the debt would increase by €12bn, wiping out the whole benefit of the austerity budget agreed last month.
Still, the very fact that today’s auctions took place shows that the bond market is still open to Italy. The bear case that the expansion of the EFSF to a hypothetical €1trn is “too little, too late” rests its logic on the size of Spain and Italy’s financing requirements (between them they are likely to need to raise that amount between now and end-2013 or so). But so long as they are able to raise debt without any assistance from the EFSF this is not entirely relevant.
It was hugely significant during the recent crash that Italy’s bond yields did not rise to dangerous levels. If they continue to hold their ground – or better yet, if confidence improves and they fall – catastrophic contagion in the eurozone is unlikely to occur. Talk about the banks, and haircuts, and credit derivatives is all very interesting. But if you really want to know how afraid to feel, just keep an eye on those bonds.
No, not the one between Mr Osborne and Mr Balls on Wednesday – the one between Portuguese prime minister Jose Socrates and the country’s opposition parties the same day. Portugal’s government saw its latest package of austerity measures defeated, Socrates resigned, the country is heading for an election and (so the consensus believes) a Greco-Irish bailout courtesy of the EU / IMF.
The consensus view finds support in recent bond market movements – specifically in the widening of the spread of Portuguese government debt over that of Germany. (Similar moves preceded the Irish bailout last November.) In fact, ten year Portuguese paper yields 4.3% more than Germany’s at time of writing – this remains well short of Greece and Ireland, at +9.1% and +6.4%, but well clear of Spain and Italy too (+1.9% and +1.5%).
Furthermore, Mr Socrates’ likely successor as Portugese PM, Pedro Passos Coelho, has been a bit cagey about his commitment to fiscal discipline and the avoidance of bailouts.
Before we treat the bailout as a foregone conclusion, however, let’s look at the numbers.
Portugal’s budget deficit on a Maastricht basis peaked in calendar ’09 at 9.3% – bigger than the eurozone average but much lower than equivalent figures for Greece, Ireland and Spain. The deficit for 2010 is estimated at 7%, and on the proposed measures was targeted to reach 4.6% this year. In the Greek and Irish cases, a large part of the problem was that deficits into 2010 were continuing to widen.
Taking a thoroughly non-random example to compare: the UK’s 2009 fiscal deficit on the same basis came in at 11.4%, is estimated at 9.8% for last year and forecast to come in at 7.9% in 2011.
Now Portugal has other problems. Its growth rate for the last ten years averaged a miserly 0.7% p.a., and unemployment, though stable, is rather high for comfort at some 11%. But it is clearly in a stronger fiscal position than the countries which have already been bailed out.
One view of Portugal’s vote this week is that it was about politics rather than economics. That Mr Coelho and his supporters are happy to continue on the path of deficit reduction – albeit by different means – but that they also want to overhaul a sclerotic economy viewed as increasingly corrupt. They must also understand that a bailout would come with austerity measures attached that would be harsher than those they have just voted down.
Ultimately, as one senior European politician put it, “Portugal won’t be left alone by the other Europeans.” We have already noted that such an attitude augurs well for the euro’s long term survival. But evidence that the eurozone’s less responsible borrowers are capable of getting their houses in order independently would bode even better.