Italy’s recovery weaker than it looks and at risk from the end of QE, warns HSBC
HSBC has warned clients that Italy’s economic recovery is weaker than it looks and the country risks a serious funding shock when the European Central Bank slashes purchases of Italian debt.
Quantitative easing by the ECB has worked wonders for Italy’s apparent fiscal health. It has mopped up half the gross supply of Italian debt, shaving at least 100 basis points off Rome’s borrowing costs. But it has not changed the country’s underlying pathologies.
“The end of QE poses a threat to Italy,” said Fabio Balboni, HSBC’s Europe economist and a former trouble-shooter during the eurozone debt crisis for the UK Treasury. “As the ECB pulls back, it will have to find new marginal buyers of its sovereign bonds. This might not be easy.”
The country must refinance debt worth 17pc of GDP next year – one of the highest ratios in the world – yet there are no obvious buyers to step into the breach. Italian banks and foreign funds have been systematic sellers.
The proceeds have been rotating into accounts in Germany or Luxembourg, pushing the Bank of Italy’s net debt through the ECB’s internal Tar- get2 payments system to €432bn. (£384bn) This is slow capital flight. The question is what level of bond yields in Italy would be required to entice it back. The ECB plans to halve the pace of QE from €60bn to €30bn a month in January. By a quirk of timing, this comes just as Italy heads into an electoral minefield over the early spring.
The ruling centrist PD party has collapsed to 24pc in the polls, giving way to a populist onslaught from anti-euro movements on the Left and Right. The insurgent Five Star Movement led by
‘It is unlikely that any government emerging from parliament will be able to push through reforms’
comedian Beppe Grillo is five points ahead. The party wants a euro referendum – as a “last resort” – if Germany refuses debt mutualisation.
On the Right, Silvio Berlusconi’s Forza Italia is fighting back with calls for the restoration of “monetary sovereignty” and a parallel currency for internal use and taxation. Critics compare this to the Italian paper debasement of the Latin Monetary Union in the 1860s. It may equally be a bargaining chip to extract concessions from Berlin.
He is likely to join forces with the Lega Nord of Matteo Salvini (at 15pc) who told The Daily Telegraph that the euro is a “crime against humanity”. It is obvious hyperbole, but revealing.
The vote may throw up three blocks incapable of working with each other. “It is unlikely that any government emerging from the highly-fragmented parliament will be able to push through major reforms,” said HSBC.
For now the eurozone is booming. The austerity chapter has been closed. This cyclical rebound has lifted Italy off the reefs after a deeper economic depression than the Thirties. But it still has a stubborn public debt of 132pc of GDP, testing the limits for a country with no sovereign central bank or currency. The International Monetary Fund said in its European outlook this week that the region is “hitting its stride” and has contributed more to the global net trade over the last year than the US and China combined.
The fund said the output gap has been closed across most of northern Europe, and companies are hitting capacity constraints. It is an implicit warning that inflationary pressures are building up. Monetary tightening must follow. The problem is that bad loans in the eurozone banks system are still $1 trillion. Debt levels in the weaker states are much higher than they were when the last crisis hit in 2008. “High-debt countries may have difficulties coping with higher borrowing costs,” the IMF said. “The lack of real income convergence along with elevated unemployment in many euro area countries could challenge the cohesion of monetary union.”
What worries IMF officials most is what happens if there is an “asymmetric shock” hitting one country or a regional cluster. The banking union is half-finished with no real backstop to avert a repeat of the sovereign/banking doom-loop that almost blew up the euro in 2012. The fund calls for a “central fiscal capacity” to act as a stabiliser.
In reality officials doubt whether Germany will agree to a genuine fiscal union. While there is a bail-out fund (ESM), the terms are so draconian that no country is willing to activate it unless in extremis. This implies that a crisis would fester first. Italy is clearly the country on everybody’s mind.
Italy’s apparent fiscal margin is an illusion of QE. The risk is that this becomes brutally apparent as soon as the ECB shield is pulled away.