The last few days have seen something of a return of a topic regular readers will find familiar. Let me hand you over briefly to the Financial Times coverage of the issue.
The spread between Italian 10-year borrowing costs and those of Germany — a key measure of stress in eurozone bond markets — rose to 1.63 percentage points, its highest level since July 2020.
The drop was even greater in Greek 10-year bonds, as their yield rose 0.3 percentage points to 2.55 per cent — the highest level since June 2019. Selling pressure was widespread and Spanish 10-year yields rose above 1.1 per cent for the first time for almost three years.
The issue here is Italy which has the largest national debt in the Euro area and that is why it is the key measure of stress. Of course it pays a yield rather than a spread and we have seen the benchmark 10-year yield rise to 1.8%. Compared to the Euro area crisis of a decade or so ago that is very low as I recall yields of the order of 7% but other things have changed as well in the meantime. Also it is low if we look at international comparisons because the US equivalent is 1.94%.
But a rising yield starts to ask questions when we note this from the Bank of Italy.
The available preliminary data for 2021 point to a significant improvement in general government net
borrowing compared with 2020. The debt-to-GDP ratio is also estimated to have fallen, by more than
was expected in the latest government estimates, to around 150 per cent (compared with levels of around
155 and almost 135 per cent in 2020 and 2019 respectively.
The January Bulletin was keen to point out the improvement but as you can see the ratio is 15% higher due to this.
In the first eleven months of 2021, the general
government borrowing requirement amounted to
€90.9 billion, €62.3 billion less than in the corresponding period of 2020…….In the first nine months of 2021, the
ratio of net borrowing to GDP declined by 2.3 percentage points compared with the same period in
2020, to 8.8 per cent.
So Italy borrowed to help pay the costs of the pandemic and now has a higher debt level. Returning to the debt to GDP ratio newer readers may like to note that the Euro area set a level of 120% in the Greek crisis to avoid embarrassing Italy in particular which backfired somewhat as she later passed it and as you can see is now well above it.
Actually there is another context as Italy has not got here by being a big spender but under Prime Minister Mario Draghi things have changed a little here.
the budgetary package approved by Parliament in December for the three years 2022-24 raises the deficit by 1.3 per cent of GDP on average per year.
The ECB as debt buyer of first resort
The emergency bond buying programme of the ECB called the PEPP took away any need for Italy to sell debt to investors. As of the end of November last year it bought some 251 billion Euros of Italian public-sector debt under the PEPP. This swamped the existing programme which was also buying but at a much slower rate. So something of a false market was created and we saw debt costs go very low but a problem is created because you lose contact with what ordinary investors might pay and in this instance it was completely lost.
If we now return to the Financial Times then the development below was bound to have an impact.
Over the weekend, Klaas Knot, the Dutch central bank head, became the first member of the ECB council to say publicly that it should raise interest rates this year, warning that eurozone inflation would stay at 4 per cent for most of this year. He called for the ECB to end net bond purchases “as soon as possible” in preparation for raising rates in the fourth quarter.
If the main and often the only buyer is gone what will the yield be then? That is what we are beginning to face up to. You do not need to take my word for it as here is President Lagarde with something of a reverse-ferret.
FRANKFURT, Feb 7 (Reuters) – There is no need for big monetary policy tightening in the euro zone as inflation is set to fall back and could stabilize around 2%, European Central Bank President Christine Lagarde said on Monday.
Quite how she thinks anyone will take her inflation forecasts seriously I do not know? But the issue for today is the risks of holding Italian debt which is why I have regularly pointed out that the ECB and its QE bond buying programme are singing along with Colonel Abrams.
Oh, oh I’m trapped
Like a fool I’m in a cage
I can’t get out
You see I’m trapped
Can’t you see I’m so confused?
I can’t get out
The Banks
As so often Monte Paschi is in the news as it has sacked its Chief Executive Officer which is hardly auspicious. Remember how securitising the banking losses was reported as a triumph?
So Monte Paschi booked a loss in Q4 because they wrote down the equity of a NPL securitization. ( Johannes Borgen)
Economic Growth
In our girlfriend in a coma theme this is the main player and let me open with a burst of good news on this front.
In the fourth quarter of 2021 the seasonally and calendar adjusted, chained volume measure of Gross
Domestic Product (GDP) increased by 0.6 per cent with respect to the previous quarter and by 6.4 per
cent over the same quarter of previous year
Italy outperformed the Euro area in the latest quarter but the Bank of Italy reminds us of the overall pandemic position.
GDP, which at the end of last summer was 1.3
percentage points below prepandemic levels, is projected
to return to those levels around the middle of this
year.
So over 2 years will have been lost against a lack of growth which has essentially been the Italian version of the “lost decade” of Japan. The Bank of Italy is optimistic looking ahead but we have seen that before morphing into yet more disappointment.
GDP is expected to increase by an annual average of 3.8 per cent in 2022, 2.5 per cent in 2023 and 1.7 per cent in
2024.
Comment
This may well be a rather different form of debt crisis. You see on an initial reading there is not much of a problem. As we stand debt costs are forecast to be 2.9% of GDP this year and then go 2.7% followed by 2.5%. Such levels will be pretty easily affordable because as we note this.
According to preliminary estimates, in January 2022 the Italian consumer price index for the whole nation (NIC) increased by 1.6% on monthly basis and by 4.8% on annual basis (from +3.9% in the previous month).
Italy has inflation which suggests nominal GDP growth will be strong as it pays its debts in nominal rather than real Euros. If the GDP forecast is correct then we could see nominal GDP growth of 7% this year making the debt affordable in those terms.
The catch is that is for the state and not Italian consumers and workers. They will be experiencing inflation on top of the many years of relative stagnation in Italy. So a cost of living crisis is in play for them and this is the stress point for the economy. As you can see below wage agreements have been rather left behind.
Growth in contractual earnings in the non-farm private sector remained modest (0.8 per cent year-on-year in both October and November; Developments in contract renewals do not point to significant wage increases in 2022. ( Bank of Italy)
Also employment has yet to recover.
The number of employed persons would grow more gradually and return to pre-crisis levels at the end of 2022.
That has a similar pattern to the UK where payroll employment has recovered but self-employment has fallen by more. The catch in the comparison is that Italy has a much higher unemployment rate (9%) and youth unemployment in particular.
So if there is to be a debt crisis I think it will be after the cost of living one.