Italy’s re­cov­ery weaker than it looks and at risk from the end of QE, warns HSBC

The Daily Telegraph - Business - - Front Page - By Am­brose Evans-Pritchard

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.

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