An Italian bullet dodged, but more in the chamber

August 29, 2013

Italy will sell up to six billion euros of five- and 10-year bonds at a somewhat inauspicious time.

Yields rose modestly at shorter-term debt sales on Tuesday and Wednesday with the government wobbling, and the prospect of the Federal Reserve reducing U.S. stimulus has put pressure on peripheral euro zone bond yields more broadly.

However, Italy’s restive coalition managed last night to reach a deal on a deeply unpopular property tax, showing it can still function despite fractures over Silvio Berlusconi’s future. On the secondary market yesterday, yields dipped in anticipation of a deal which will abolish the tax from the beginning of 2014 to be replaced by a “service tax”.

Berlusconi’s centre-right PDL had demanded the housing tax be scrapped as the price for supporting centre-left Prime Minister Enrico Letta, though it will rob the debt-laden state of 4 billion euros a year.

The details of the service tax could yet foment more discord between the parties but for now it’s a bullet dodged. There will also be an increase in gambling taxes and further spending cuts which have yet to be been finalized.

Whether that helps borrowing costs fall remains to be seen given some in the PDL are threatening to bring down the government and trigger early elections if Berlusconi is barred from parliament in a vote next month. If he is not expelled, Letta’s 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.

A raft of German data is unlikely to shift the weight of evidence that Europe’s largest economy is recovering. The GfK measure of consumer morale is already out and showed confidence eased slightly going into September but remained near a six-year high.
The unemployment rate is expected to stick at 6.8 percent, around the lowest level since the country’s reunification two decades ago. A solid jobs market, combined with wage increases and low inflation, is fuelling private consumption and has helped bolster the economy.

German inflation is also due and forecast to drop to 1.7 percent from 1.9, which was pretty much bang on the European Central Bank’s target.

A number of ECB policymakers – Yves Mersch, Jens Weidmann and Ewald Nowotny – speak during the day. They are all sticking to the central bank’s forward guidance that interest rates will remain at record lows or fall yet further over an extended period.
They will continue to do so though the euro zone’s exit from recession and Germany’s resurgence makes a rate cut increasingly less likely.

All else being equal, an improving economy should bolster Angela Merkel as she heads to Sept. 22 elections. Today, opposition centre-left SPD leader Peer Steinbrueck faces the media to present his policy priorities.

Finance Minister Wolfgang Schaeuble’s admission that Greece will require more aid could be fertile ground for the SPD but Merkel has already positioned for that, stating that Greece should never have been let into the euro zone – a decision presided over by former SPD Chancellor Gerhard Schroeder.

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