MacroScope

Italian market test

By Mike Peacock
September 12, 2013

Italy will auction three different bonds, aiming to raise 7.5 billion euros against a volatile domestic backdrop.

A sale of one-year bills on Wednesday saw yields rise, this after the Treasury asked parliament to raise the ceiling on this year’s net debt issuance to 98 billion euros from 80 billion, given the struggle to rein in public finances and a government commitment to pay outstanding bills to firms, which at least could give the economy a boost.

Parliamentarians have a bigger fish to fry in the form of Silvio Berlusconi. A cross-party Senate committee that must decide on whether to bar him from political life drew back from the brink on Tuesday but has caused growing tension between the coalition parties with some of Berlusconi’s allies threatening to pull the shaky government down.

Together, Prime Minister Enrico Letta’s centre-left Democratic Party and the anti-establishment 5-Star Movement have the numbers on the committee to force the issue but the delay suggests a scramble to find a face-saving compromise. One of Berlusconi’s bloc has suggested he could resign to circumvent the process in anticipation of a later pardon from the presidency.

A full and final vote by the Senate is now expected in mid-October so uncertainty will reign for some time just as the Federal Reserve prepares to start throttling back its monetary stimulus and with German elections only 10 days away. Letta told parliament last night that political turmoil was pushing Italian borrowing costs higher, which is undeniable.

Italian bond yields have already clambered above Spain’s for the first time in 18 months which is bonkers if you look only at the underlying economic fundamentals. Italy’s economy minister said yesterday the budget deficit will hold under three percent of GDP this year while Spain’s will hit 6.5 percent, and that’s just one metric example. But the fact is that unless a durable Italian government capable of pushing through meaningful economic reforms results from this standoff, there could be worse to come.

After Britain’s unemployment rate prompted a new bout of monetary policy speculation by falling a minute amount on Wednesday, Bank of England Governor Mark Carney and colleagues get another chance to convince markets of their forward guidance when they testify to a parliamentary committee on their last quarterly inflation report.

Carney has struggled to convince markets of his contention that interest rates are unlikely to rise for three years because the jobless rate will fall only very slowly.

The jobless rate fell to 7.7 percent from 7.8 yesterday and Carney says rates won’t rise until it is at 7 percent or below, something he expects to take until late 2016. Investors don’t believe it will take anything like that long and it’s not hard to see why given the summer run of strong economic data which has propelled Britain’s economy off its sick bed.

European Central Bank President Mario Draghi makes a speech and holds a press conference in Riga after his colleague, Joerg Asmussen, warned that without careful handling the impact of the U.S. central bank unwinding its policy stimulus risks being greater now than in 1994, when it started a tightening cycle and bond markets crashed. The effect could be even more marked now since the world is far more deeply interconnected, he argued.

Draghi said last week that if market interest rates climbed too far, an official interest rate cut or more liquidity pumped into the financial system could not be ruled out. On Wednesday, Estonian ECB Governing Council member Ardo Hansson said offering more long-term loans to banks – a repeat of last year’s LTRO — was a potential policy tool but was not needed just yet.

For both Draghi and Carney, the central question is whether they can hope to keep a lid on market interest rates via forward guidance at the same time as the world’s dominant central bank begins reversing course.

Draghi may also have something to say about euro banking union which is moving at a glacial pace although today the European Parliament will belatedly vote through the ECB’s new powers to supervise banks, effective from some point next year. EU economics commission Rehn will also speak in Riga while fellow commissioner Michel Barnier – the man responsible for banking regulation – makes a speech in Frankfurt.

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