This week Italy was carted into the spotlight of the Eurozone crisis as its benchmark 10 year borrowing costs moved above 6 percent for the first time since January and with Italy now beginning to suffer as contagion spreads from the currency block’s other problem areas it is clear that tensions are rising in the Euro area.
In a further sign of disunity between the Eurozone’s Latin bloc and other EMU member states on Tuesday, Italian Prime Minister, Mario Monti, was forced to reject claims from the Austrian Finance Minster that Italy would require financial assistance. Italy is now seen as the final battleground of the euro project with any bailout for Italy likely to be the final nail in the coffin of the Eurozone.
Having been widely praised for his reform agenda, including the modernisation of antiquated labour laws as well as unprecedented public pension cuts, it appears that the wheels are starting to fall off. Two unconvincing auctions of short and long term debt this week underscored Italy’s need to go further to ensure the confidence of the markets. Battling with public debt levels of 120 percent of GDP, a contracting economy and resentment to reform, a sense of urgency is increasing as Monti’s government tries to distance itself from the other weak periphery countries.
With the honeymoon period well and truly over, Mario Monti is facing an on-going backlash against his reform agenda - perhaps made more poignant due to the fact that he is not a directly elected head of state – but an appointed technocrat. Struggling to push through reforms, Monti has increased the rhetoric against the Eurozone creditor nations and the European Central Bank addressing the increased need for a collaborative growth agenda.
Italy’s growing alliance with the region’s Latin block, who champion a growth agenda with less focus on austerity, is calling for a greater role for the European Central Bank to boost the region’s ailing economies. They want to allow the Eurozone’s new rescue fund, the ESM, to be able to borrow directly from the ECB in order to install a credible firewall to stop the further spread of contagion. This stance is currently rejected by Germany and the ECB whose president, Mario Draghi, has reaffirmed the bank’s limited role and has stressed the need for Eurozone governments to enact the required fiscal reforms.
The ECB, having orchestrated a major liquidity injection via its LTRO policy move in November, sees itself only as a last resort participant in being able to prevent short run crisis but not as the driver of the long run sustainability of the Eurozone. The positive effect of the LTRO on peripheral sovereign bond yields had died off by the spring as Eurozone banks hoarded the extra cash on their balance sheets amid increasing uncertainty. At the main press conference following the ECB’s June interest rate setting meeting, Mario Draghi made it painstakingly clear that the baton had been handed to the Eurozone governments, with the focus now on them to implement the necessary reforms.
What is clear is that, if the current trend in the Eurozone continues, Italy is on the slippery slope towards a full blown debt crisis and therefore the catalyst of a full Eurozone collapse. This scenario is exacerbated by the ECB’s insistence on its limited role stressing that the Euro group as a whole needs to deliver solutions that promote fiscal sustainability across the region. With the markets exerting more pressure by the week and the two Marios tugging in different directions we wait to see who will blink first. Be warned the stakes are high.