Stay of execution?

October 2, 2013

No sign of movement on the U.S. government shutdown but in Italy, party talks have been running red hot, keeping Italian markets in thrall.

Yesterday, senior figures in Silvio Berlusconi’s PDL party urged their colleagues to defy the former premier and back Prime Minister Enrico Letta in a parliamentary confidence vote expected today. Most tellingly, the media mogul’s key ally, Interior Minister Angelino Alfano, called on the party to back Letta.

Now nothing is certain in Italian politics and sources close to Letta say he will not call a vote if the numbers aren’t there, and could resign instead. But given he has a firm grip on the lower house, if even some PDL members support him in the Senate he should win the vote.

He needs a minimum of 20 from the other side to back him. One PDL source told us about 30 party senators could back him and some in the anti-establishment Five Star movement could also lend their support.

Caveats? Plenty as usual. Letta has already said scraping through would be insufficient to continue a government tasked with economic reform. So he needs solid cross-party support to be able to function and, crucially, pass a 2014 budget bill.

The likelihood is that this is only a stay of execution for a coalition that has seemed ill-fated throughout its seven months in power. Elections in the spring are quite likely and without a change to the electoral law another splintered result, leading to an unstable government, is on the cards.
But for the markets, any breathing space is better than none and Italian bond futures have opened 50 ticks higher.

For Berlusconi, Italy’s Lazarus, it is always dangerous to say the game’s up but if Letta wins the confidence vote and the government is not felled this must surely be a pivotal moment for a man who faces a special Senate committee meeting on Friday which is expected to open proceedings that could throw him out of parliament following his tax fraud conviction and rob him of his parliamentary immunity.

The European Central Bank meets a day earlier than usual, and in Paris (one of its two “offsites” of the year). Don’t expect any fireworks but there will be plenty to sift through from Mario Draghi’s statements.

Draghi hardened expectations last week that the central bank could throw more long-term liquidity at the banks if money market rates climb too far. Subsequent utterings from his colleagues have been more mixed but one presumes Draghi must be taken at his word that the ECB will act to curtail de facto policy tightening on the markets if necessary …

… but not yet, given the turbulence surrounding the U.S. government shutdown and the fact that the Federal Reserve – by taking its finger off the trigger and continuing its money-printing untapered – has done what the ECB had failed to and taken some of the steam out of rising short-term market interest rates.

The rule of thumb is that if “excess liquidity” in the money market – which is shrinking quite fast now as banks repay last year’s LTRO offerings – drops much below 150 billion euros, then the rates at which banks lend to each other are likely to be squeezed higher. Excess liquidity at the last count was just above 200 billion euros and falling by several billion a week so the ECB may have to act before long and it could even require an interest rate cut to rectify.

A Reuters poll of economists found 42 of 56 expect another long-term liquidity operation to at some point, with opinion divided as to whether it will happen before year-end. If a liquidity squeeze is not the trigger, the ECB’s stress test of banks – the asset quality review – could well be if it exposes dark holes when it reports in the early part of 2014.

Italy will not impinge upon the ECB’s thinking yet, not least because investors still believe in the ECB’s backstopping of the euro zone without seriously putting it to the test.

According to its rules, the central bank could only buy Italian bonds if Rome asked for help from the euro zone’s rescue fund which would come with strings attached. We’re a long way from that yet and it’s worth remembering Draghi’s precise words from that summer day in 2012: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”

The beginning and end of that statement bear close scrutiny. Italy is certainly too big to fail and in extremis, the ECB’s mandate comfortably extends to it preventing an existential threat to the currency bloc, so it will do what it has to and it will “be enough”, whatever the rules and regulations say.

Where Draghi might be drawn though is on banking union and the increasingly tight timeline to reach agreement on a mechanism to restructure or wind up failing banks, which is still on hold as German coalition talks are only beginning, and next year will run into European parliament elections.
Yves Mersch said last week that the ECB will not take on its supervisory role, which it is supposed to late next year, without a backstop in place and the prospect of the central bank conducting its stress tests of euro zone banks beforehand is also a worrying one, given the holes that could be uncovered.

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