As we survey the present economic scene the return of higher bond yields turns minds to the countries most likely to be affected. One of those is Italy and you do not have to take my word for it because the ECB has admitted it below.
The Governing Council today approved the Transmission Protection Instrument (TPI)……..Subject to fulfilling established criteria, the Eurosystem will be able to make secondary market purchases of securities issued in jurisdictions experiencing a deterioration in financing conditions not warranted by country-specific fundamentals, to counter risks to the transmission mechanism to the extent necessary.
That was from July last year when the ECB felt the need to get itself ready in case it needed to defend Italy from the bond vigilantes. That was awkward on two counts. The first is simply that it was trying to exit from QE bond purchases due to the surge in inflation.The second is that it holds so many Italian bonds or BTPs due to the scale of its past purchases. For example the Covid emergency purchases or PEPP amounted to 288 billion Euros. This added to the 442 billion under the existing programme called APP.
All this is materal because the TPI was introduced because the ten-year yield in Italy went above 4.2% in the middle of June 2022. Or as the FT put it a day or 2 before.
It touched an eight-year high of 4.06 per cent on Tuesday.
My point is that it nudged 4.6% this morning. So from the point of view of Italy things are more uncomfortable now.
We can review this via the words of the Governor of the Bank of Italy Ignazio Visco who spoke at OMFF on the 3rd of November.
Reasonably relaxed over increasing government debt costs, Visco said that he does not anticipate rate hikes having ‘major effects on the burden of the debt of any country’.
That looks like an official denial so let us look deeper.
Nominal rates have gone up globally, but real rates remain negative at a time when the debt burden, with an average maturity of around eight years, is manageable.
Also he was keen to emphasise this.
Despite the worsening outlook, Italy’s debt-to-GDP ratio continues to improve. It is currently estimated at around 145 per cent in 2022, 5 percentage points less than in 2021 and 10 points less than the peak achieved in 2020: about half of the increase recorded due to the pandemics has therefore been recovered.
This attracts my attention because official statements always tell us of an expected improving situation, but if you fo away for a way and then check then they are again higher. For example in the Euro area crisis a level of 120% debt to GDP was sey for Greece to avoid embarrassing countries like Italy and yet we see 145% mentioned by the Governor. In fact his speech illustrates my point nicely.
General government net borrowing is currently projected on a descending path. In the latest assessment
by the Italian Ministry of Economics and Finance, it would settle at about 5 per cent of GDP this year and just above 3 per cent next year (against over 7 per cent in 2021
and 9.5 per cent in 2020).
This week we were told this.
General Government net borrowing was -153,447 million euro: -8.0 % of GDP, compared with -9.0 % in 2021. This ratio has been revised for the years 2020 and 2021 as a result of the change introduced in the accounting treatment of tax credits ( Italy Statistics Office)
So 8% is the new 5% and remember we were only told that in November! Also other numbers were revised higher.
This change resulted in a revision of the deficit/GDP ratio for the years 2020 and 2021, compared to the
estimate provided in September 2022, by -0.2 and by -1.8 percentage points, respectively.
We can also return to his view of the debt to GDP ratio which was 145% and falling quickly whereas we are now told it ended 2022 at 145%. According to the updated figures we see that it went as high as 156% in 2020. In a way it is kind of him to so quickly conform my thene.
The change is around the treatment of tax credits given during the pandemic which looks to be a growing scandal. I understand that there are elements of fraud and now builders thinking they will not be paid for work from this.
The most generous, introduced in 2020 and being phased out, paid an eye-watering 110% of the cost of making buildings more energy-efficient, from insulation to solar panels to replacing old-fashioned boilers and window fittings.
The 110% ‘superbonus’ was introduced in 2020 under a centre-left administration, but the government said it proved too expensive, costing more than 100 billion euros, with only the wealthiest people using it. ( Reuters )
If I was looking for scandals these sort of “green” moves are where I would start especially if you get 110% of your money back and that is before this.
“We have decided to stop the effects of a wicked policy that has benefited a few citizens but has placed a burden on each of us from the cradle onwards of 2,000 euro per head,” minister Giancarlo Giorgetti told a news conference after the end of a cabinet meeting.” ( Reuters)
It all seems rather Italian but I may be biased at the moment as I watched the Godfather part II last night.
Bank of Italy losses
We know there is a problem by the way that Governor Visco deflected this back in November.
At least in the short term, Visco acknowledged that central banks will now be making small or no profits — and that this is something governments will have to accept in view of the large profits that central banks have paid over to finance ministries in previous years.
“in the short-term?” Anyway we do know that QE was a great game both for central banks and governments.
Gross profit before tax and transfers to the general risk provision was €9,181 million, lower than the €10,196 million recorded in 2020.
Profits were made and money flowed back to the Italian Treasury.
The amount assigned to the State is equal to €5,565 million.
But the interest-rate increases of late 2022 and this year have changed that. Earlier this week we found out more about the change in the position of the German Bundesbank.
The profit and loss account for 2022 reported a distributable profit of zero. This result was achieved by tapping €1 billion worth of risk provisions………..The burdens on the Bundesbank’s balance sheet are likely to increase considerably in the years to come owing to the high holdings of securities and the interest rate reversal.
The losses so far are only from the latter part of last year. So this year will be much worse because it will be for the whole year and interest-rates have already been raised again and we are expecting at least another 0.5%.
There is a nuance to all of this as things are different in several ways from the 2012 Euro area crisis. Firstly inflation is a benefit for government’s as it does exactly that to tax revenues and most debt is at a fixed yield when issued. Secondly there are the ECB holdings and the prospect of it buying more whether through activation of the TPI or through more widespread QE bond buying.
But there is another side to this and it is that the ordinary Italian worker and consumer is being hit hard. So the burden of a debt crisis has shifted. They will face a higher tax burden to due inflation. Plus there is the effect of this on real wages.
In February 2023, according to preliminary estimates, the Italian harmonised index of consumer prices (HICP) increased by 0.2% on monthly basis and by 9.9% on annual basis (from +10.7% in January).
Also there is the issue of the Bank of Italy which is responsible tor explicitly owning some 82% of the ECB bond position. We have looked at the “carry” cost of buying at negative yileds and paying soon to be 3%.For a start who ever thought that buying Italian bonds at a negative yield was a good idea? But there are also losses in capital terms. We can use the Italian bond future as some sort of guide. There were sustained spells when the Bank of Italy was buying at over 150 and the present price is 112. A private-sector trading book like that would have been shut down long ago
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