Friday 23 February 2018

The bonds that tie Italy down may destroy crisis-hit euro

Louise McBride asks what now for the eurozone after the yield on Italian bonds soared to 7.5 per cent

Louise McBride

Louise McBride

ITALY almost pushed the eurozone over the cliff last week after the country's borrowing costs soared to alarming levels. It's 10-year bond yields, the amount of money the country must pay to borrow money over a decade, hit a record high of 7.5 per cent at one stage -- a level deemed the point of no return for a country with a massive €1.3trn debt.

Panic gripped Europe as a result and rumours of a eurozone break-up mounted. So with EU political leaders at gunpoint to resolve the eurozone's debt crisis once and for all, what might be on the cards for Europe in the coming months?


THE European Central Bank (ECB) is under pressure to ramp up its purchases of Italian government debt. Although the ECB has been buying Italian government debt since last August, it hasn't been doing so fast enough to prevent Italy's borrowing costs spiralling out of control.

"The ECB needs to be the 'bazooka' that changes market sentiment about sovereigns in the euro-zone," said Dermot O'Leary, chief economist with Goodbody Stockbrokers. "If a new Italian government is formed next week and reforms are swiftly implemented, we could see the ECB step up purchases of Italian bonds and yields start to come down." Alan McQuaid, chief economist of Bloxham Stockbrokers, believes the ECB is "the only solution" to the eurozone's debt crisis. "The ECB is the lender of last resort and it must start to buy up more government bonds," said McQuaid.


Italy's borrowing costs were last week higher than those faced by Ireland, Greece and Portugal before they were forced to seek a bailout from the EU and International Monetary Fund (IMF). As Italy has the third largest economy in the eurozone it is, however, deemed to be too big to bail out. "A bailout for Italy could sink Europe," said McQuaid.

Despite this, Italy and Europe might soon have no choice -- key European players warned last week that Italy was running out of time to avoid a bailout.


German Chancellor Angela Merkel and French President Nicolas Sarkozy were reportedly plotting a two-tier eurozone last week. If this were to happen, vulnerable debt-ridden countries such as Greece and Italy would be kicked out of the current eurozone; while its stronger and wealthier members would hold onto the euro and form a smaller and more integrated economic area. Those countries turfed out would either take on a 'softer' and less valuable euro, or introduce their own national currency.

Germany has so far opposed the ECB ramping up its purchases of government debt, which some believe is the only viable solution to the debt crisis.

"If Germany doesn't give into the bond thing, there's no doubt a two-tier eurozone is a possibility," said McQuaid.


It's considered unlikely, but if the debt crisis is not resolved soon the euro could collapse altogether. This would see countries reinstate their own currencies. European Commission president Jose Manuel Barroso warned last week that the collapse of the euro would wipe out half the value of eurozone economy and plunge the continent into a deep depression.


IF the eurozone doesn't break up, many believe the only way it can survive going forward is through greater fiscal and political integration. That would not only spell the end of each country collecting its own taxes and setting its own budgets, it would also see wealthy countries such as France and Germany assuming the debts of vulnerable countries. "It is now clear that a currency shared by fiscally sovereign member states is more vulnerable to losses of confidence than a monetary union that is more fully integrated," said the Centre for European Reform (CER) in a paper published last week.

Banking authorities in individual countries would also become redundant as much of their supervisory powers would move to the European banking regulator, the European Banking Authority (EBA). "The eurozone crisis has shown that a shared currency with an increasingly integrated financial sector cannot comfortably co-exist with national regimes for supervising, rescuing and 'resolving' banks," said the CER. "The problem is not just that the supervisory architecture is not sufficiently effective, but also that the system is more prone to banking and sovereign debt crises that feed on each other."

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