THE eurozone debt crisis has gone from a slow-moving wreck that was being dragged out over two years to moving at breakneck pace in only a few days. Italian 10-year sovereign bonds yields have broken through the key 7pc benchmark. This is the level at which Greece, Ireland and Portugal were forced to seek assistance from an EU/IMF bailout. Italy is not in the same category as the original PIGs ... and the difference is one of scale.

At the end of 2010 Greece, Ireland and Portugal had a total government debt of €640 billion. On its own Italy had a debt of €1,840 billion or €1.8 trillion.

Italy is too big to bail.

When the eurozone leaders met in Brussels just over a week ago some huge steps were taken. It was finally realised that Greek debt was too high and needed to be reduced. It was finally realised that European banks were in trouble and needed to be recapitalised and it was finally realised that the eurozone bailout fund was too small and needed to be increased. These were all significant concessions, particularly from France and Germany, the biggest eurozone economies.

While there seemed be belated acceptance of the scale of the problems facing the eurozone the proposals agreed in Brussels last week did not go far enough. There were very few who felt that enough was done to finally resolve the eurozone crisis.

Greek government debt was reduced by 30pc but it is clear that a reduction of 60pc or more is needed to get Greek debt onto a sustainable path. European banks were required to raise €100bn of new capital when €200bn is actually needed to restore confidence in the banking system. The bailout fund, the European Financial Stability Fund, was set to be increased to €1,000bn (€1 trillion) but with the Italian domino about to fall a fund of at least €2 trillion is required.

In all cases the eurozone leaders went in the right direction, but in all cases they came up short by half. It was probably felt that the steps taken were significant in their own right and that if further measures were required they could wait until a subsequent summit in the spring. This was politics coming before economics.

As we have seen markets don’t wait for bureaucrats to catch up. Although Greece was getting a 30pc reduction in its debt, it was clear that this was not a good package for Greece. Former prime minister, George Papandreou, made the ill-fated call for a referendum which led to a remarkable display of petulance from Angela Merkel and Nicolas Sarkozy and ultimately the end of Papandreou. Greek debt is too high and it is still not clear what will be done to reduce it.

Attention then shifted to Italy and the soft leadership of Silvio Berlusconi. Although Italy has problems it is facing them from a position of strength relative to Greece. The belief is not so much that Italy needs to default on its debts, more that it needs to put its government finances on a firmer footing.

At the end of this year Italy will have government debt of 120pc of GDP and will be running an annual deficit of 4.3pc of GDP. In fact, if you omit interest payments and look at Italy’s primary balance is running a surplus of more than 1pc of GDP. By contrast, Greece is heading for a debt level of 160pc of GDP and has an annul deficit of 10pc of GDP.

While Greek debt is hurtling towards 200pc of GDP and default is inevitable, Italian debt is forecast to stay on around 120pc for the next five years. This prediction for Italy is based on economic growth and 1.5pc per year and inflation of 2.0pc per year. These seem to be reasonable assumptions and one might wonder what doubts have caused Italian yields to soar today.

There are two problems. First, although economic growth of 1.5pc might seem low it is above the 1pc annual growth that Italy has delivered for the past ten years. Secondly, Italy has a problem of soft leadership. For the past 18 month Berlusconi has been making soothing claims to other EU leaders that he would take steps to bring the Italian deficit back under 3pc of GDP.

As the deficit never got above 5pc of GDP this target is not one that would have been difficult to achieve. However, Berlusconi procrastinated and despite all the promises made at EU level the necessary measures were never introduced. As a result of this, and many other weaknesses, Berlusconi lost his overall majority and was forced to resign.

The Italian public finance problem can be addressed but it is not clear that the required leadership exists to take control of the situation. Doubts about Italy’s moribund growth has always existed but it is not clear that a change in leadership will be able to change that.

These doubts about the Italian government and economy have been added to the realisation that the eurozone leaders have not gone far enough to solve the overall problem. Markets do not have the patience to wait for political leaders to take the necessary steps. As has been the case for most of this crisis, markets have always been a few steps ahead of the politicians.

Where to from here? In the immediate term, yields above 7pc do not present a threat to Italy. The yield is just the return buyers of Italian bonds get from buying off existing holders of these bonds. The problem arises when Italy wishes to raise new debt and Italy’s next bond auction is not scheduled to take place until next week.

This auction may still go ahead but if Italy is forced to borrow at these rates for any sustained period it will then have to turn to an official bailout. When Greek, Ireland and Portuguese yields went above 7pc they were in an official bailout in an average of three weeks. If, or even when, that happens the steps taken in Brussels a week ago will seem miniscule.

The ESFS is set to be increased to €1 trillion though it is still unclear where this money is going to come from. From an Italian perspective the ESFS is very attractive. Greece, Ireland and Portugal were forced out of bond markets because of the failure of their economies and can now borrow from the ESFS at rates of around 3.5pc.

Italy is outside a bailout programme and faces costs on new borrowing of more than 7pc. There is a perverse incentive for Italy the borrow from the EFSF. The problem is that the EFSF is just not big enough.

This is where the European Central Bank is supposed to step in. As a central bank the ECB has an unlimited capacity to create money. If Italy cannot sell new bonds on the open market, they could sell them to the ECB. This is the ‘government lender of last resort’ function of central banks.

The ECB was not designed to act in such a capacity and in his first press conference a week ago, new ECB President, Mario Draghi (who is Italian) re-emphasised the stance of the bank not to engage in such actions. This was designed with the aim of imposing discipline on national governments. This clearly has not happened. Fiscal indiscipline is largely the genesis of this crisis.

The ECB has stepped into secondary bond markets and bought existing government bonds. This was supposed to keep yields down by providing additional demand. With Italian yields hurtling towards 7.5pc and beyond it is not clear what the ECB is doing at the moment. Very little is the guess of many.

Unlike Greece, the Italian situation is not the story of a failed economy. The Italian economy has problems but we are now seeing the impact of failed leadership at EU level. The political leaders may have felt they took huge steps in Brussels last week, but they need to get up to pace with the crisis right now.

The measures introduced last week need to be doubled and a credible lender of last resort needs to be created for eurozone counties. Politics means we must wait as long as possible until these are introduced. Economics requires that we have them now. The future of the common currency depends on it.

Seamus Coffey is a lecturer in economics at UCC and a blogger at http://economic-incentives.blogspot.com

- Seamus Coffey