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, economists say.
Nine out of 10 economists in a Financial Times poll identified Italy as the eurozone country “most at risk of an uncorrelated sell-off in government bond markets”.
Italy’s right-wing coalition government, which took power in October under prime minister Giorgia Meloni, is trying to follow a fiscal path. He has budgeted the country’s fiscal deficit to drop from 5.6 percent of GDP in 2022 to 4.5 percent in 2023 and 3 percent the following year.
But Italy’s public debt remains one of the highest in Europe at more than 145 percent of gross domestic product. Marco Valli, chief economist at the Italian bank UniCredit, said the country’s “high need for debt refinancing” and “difficult potential” political situation makes it the most vulnerable to sell-off in the bond market.
Rome’s borrowing costs have risen sharply since the ECB began raising interest rates last summer. The 10-year bond yield rose above 4.6 percent last week, nearly four times the level a year ago and 2.1 percentage points above the same yield on German bonds.
Meloni has expressed disappointment at the ECB’s willingness to raise rates despite risks to growth and financial stability. “It would be useful if the ECB handles communication well. . . Otherwise, there is a risk of not panic but fluctuations in the market that cancel out the efforts made by the government,” he said at a press conference last week.
The new Italian government has “given investors some reason to worry now”, said Veronika Roharova, head of the euro area economy at Swiss bank Credit Suisse. “But concerns could resurface as growth slows, interest rates rise again and [debt] publishing is taking it back,” he added.
ECB rate-setters have confirmed they will continue to raise rates by an additional half point in the early months of this year. Klaas Knot, governor of the Dutch central bank and one of the governing council’s governors, told the FT the central bank had only started the “second half” of its rate hike cycle.
However, analysts believe that the ECB is overestimating the risk of inflation – and underestimating the prospect of a recession. IMF managing director Kristalina Georgieva said at the weekend that half of the EU will be hit by recession this year. Four-fifths of 37 economists polled by the FT in December forecast the ECB would stop raising rates in the first six months of 2023 and two-thirds predicted they would start cutting next year in response to weaker growth.
On average they predicted that the ECB’s deposit rate will peak at just under 3 percent, below the rate investors are betting on as indicated by the interest rate swap price.
A separate FT poll of more than 100 UK-based economists says the UK will suffer one of the worst recessions and the weakest recovery of the G7 by 2023.
Central banks around the world have raised rates rapidly to tackle inflation, which has been rising for decades in many countries, as energy and food prices rose after Russia’s invasion of Ukraine and the end of the coronavirus pandemic lockdown hit demand for goods and services. .
The ECB is slower than many western central banks to start raising rates, but since the end of summer has tightened policy at an unprecedented pace, raising the deposit rate from minus 0.5 percent to 2 percent in six months.
“The ECB is very slow [in] understand that inflation is not temporary, but now it is accelerating,” said Jesper Rangvid, professor of finance at the Copenhagen Business School. However, I am still afraid that the ECB will not tighten because of the problems that will arise in Italy.
The ECB is due to start shrinking its €5tn bond portfolio by €15bn a month from March by replacing maturing securities only, adding to upward pressure on Italy’s borrowing costs. Ludovic Subran, chief economist at the German insurer Allianz, said the euro zone risked a repeat of the 2012 meltdown of the bloc’s bond market “because of the different fiscal capabilities between countries without the ECB’s heavy lifting”.
Italian cabinet ministers have criticized the ECB for its aggressive monetary tightening. Defense Minister Guido Crosetto wrote on Twitter that the ECB’s policy was “making no sense” while deputy prime minister Matteo Salvini said higher rates “will burn billions in Italian savings”.
Silvia Ardagna, chief European economist at the British bank Barclays, said that Italy’s “high debt stock, rising fiscal deficit and the need for additional energy support measures . . . makes the market very concerned”.
The ECB has unveiled a new bond-buying scheme, known as the transmission protection instrument, designed to deal with unexpected rises in the cost of sovereign debt. However, more than two-thirds of economists polled by the FT in December said they expected the ECB not to use it.
Mujtaba Rahman, managing director of Europe for consultancy Eurasia Group, said that a deeper than expected recession next year “could put deficit, high debt countries under greater pressure” adding that this “may create a smoother path for monetary policy from the ECB”.
Additional reporting by Amy Kazmin in Rome