Italy housing tax showdown

August 28, 2013


Italy’s fraying coalition cabinet meets to discuss what to do with a property tax imposed by previous premier Mario Monti.

Silvio Berlusconi’s centre-right group wants to scrap it – though that would create a 4 billion euro annual financial gap to be filled elsewhere – while the centre-left PD of Prime Minister Enrico Letta wants to keep it for the rich, which would cost only 2 billion euros. The argument has already stalled decisions on more wide-ranging economic reforms. A percentage point rise in the main rate of value-added tax has already been pushed back to October from July and will need to be discussed again too.

The big question is whether the government is effectively paralysed until a vote next month on whether to bar Berlusconi from parliament following the upholding of his tax fraud conviction. Members of his centre-right PDL are threatening to bring down the government and trigger early elections if he is expelled. If he is not barred, swathes of Letta’s centre-left PD would react with horror.

It could be an act of folly for any of the parties to hasten early elections, given how unpredictable the result would be. So there’s a good chance that won’t happen. But it’s a live risk and one that has started feeding into the markets with Italian debt markedly underperforming Spain’s for starters. Italy will sell six-month treasury bills after domestic demand helped keep a lid on rising yields at an auction of zero-coupon bonds on Tuesday. The bigger test comes with a 5- and 10-year Italian bond auction on Thursday.

After declaring that British interest rates could remain at a record low 0.5 percent for three years, Mark Carney makes his first major policy speech as Bank of England Governor and holds a press conference to boot. His first and main task will be to convince doubting investors that his forward guidance on rates is credible. The market consensus is that rates will rise by 2015, not 2016, with next year not out of the question.

With growth clearly picking up, Carney will have some explaining to do though he can legitimately point to the fact that the economy has not even recovered to the level of output it was operating at before the world financial crisis of 2007-2009. In fact it is 3 percent below it. The problem is that no one is sure how much of that activity has been permanently lost, so it is difficult to judge at what point inflation pressures may start to build – the great output gap debate.

The limits of forward guidance are already being demonstrated at the European Central Bank. With the euro zone out of recession, expectations of any further rate cuts are evaporating. Only two months ago the ECB broke with precedent by saying that rates would stay at record lows or even go lower over an extended period. Its monthly policy meeting falls next week and in a parallel transparent world Mario Draghi could consign the “or lower” part of the guidance to history. That won’t happen but it shows how quickly things can change.

The Bank of England reckons it could take three years for UK unemployment to drop from 7.8 percent to the 7 percent level below which it said it may tighten policy. Maybe, maybe not. The bottom line is that if anyone in the euro zone, Britain or elsewhere is hoping for a cast iron guarantee that rates won’t rise for two, three or more years, forget it.

Emerging markets have had a torrid time since the Federal Reserve announced its intention to slow the pace of its money-printing. Countries with domestic problems to add to the mix have been particularly hard hit and now the prospect of military action against Syria is ushering investors further towards safe havens.

The Turkish lira has weakened further early today having zipped through 2 per dollar for the first time on Tuesday. The central bank is steadfastly insisting it won’t raise benchmark interest rates to defend the currency but has called a dollar-selling auction. It burnt through a sizeable chunk of its reserves playing that game earlier in the summer.

South Africa’s rand headed in the same direction yesterday. Strikes are ongoing in auto manufacturing, construction and the gold miners could soon follow suit. That could hit growth and cut minerals for export – a major source of foreign exchange.
Interestingly, while not immune to all this, central and eastern European markets have not been hit as hard with investors focusing on its links and proximity to a euro zone that may just have turned the corner.

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