Italy is facing a public finance and bond market crisis

As I noted earlier this week there is a rise in bond yields happening and at this moment the heat is being felt in Italy as its ten-year yield has reached 4.8% this morning. This raises particular concerns in a country with so much public debt. In fact it has the largest national debt in the Euro area in spite of being only the third largest economy. According to the Bank of Italy it rose above 2.85 trillion Euros in July and they own some 721 billion of it. The debt to GDP ratio was 144.7% in 2020. So as you can see higher bond yields are an issue and the longer they last the higher the future bill will be.

italy has to refinance 400 billion of public debt in the next 12 months, ( @spaghettilisbon )

So it is like a ticking clock because whilst the bill may be very minor this week it is like a snowball rolling down a hill. Also a factor here is that Italy is having much less support from the Bank of Italy and ECB ( the split in QE purchases is usually 82%/18%) because as you can see from the 721 billion the Bank of Italy has selling debt was oiled by its purchases.

Budget Problems

The Meloni government has added to the general pressure on bond yields with this.

ROME, Sept 25 (Reuters) – Italy’s government plans to raise its 2024 budget deficit target to between 4.1% and 4.3% of gross domestic product (GDP), up from the 3.7% goal set in April, sources familiar with the matter told Reuters on Monday.

As Paul Simon would say the deficit targets are slip-sliding away. This puts the Italian government on a bit of a collision course with this.

As the energy crisis fades, governments should continue to roll back the related support measures to avoid driving up medium-term inflationary pressures. At the same time, fiscal policies should be designed to make the euro area economy more productive and to gradually bring down high public debt.

That was from ECB President Lagarde at the European Parliament on Monday and rather feels targeted at Italy, which I have noted is heading in the opposite direction.

Returning to the Reuters report we can see that clearly.

Among her top priorities, Meloni intends to earmark more than 9 billion euros ($9.5 billion) to extend to 2024 the tax cuts that have helped middle and low-income workers cope with high consumer prices this year.

Also it is not only next year where there is trouble on the borrowing front.

Italy is also preparing to raise this year’s budget deficit above the current target of 4.5% of GDP due to the growing impact of costly fiscal incentives for home improvements.Separate sources last week said the updated 2023 goal would be in the region of 5.5%

Those with experience of Italy may already be fearing what “in the region of 5.5%” means in practice although hopefully Eurostat is providing a little more discipline.For those wondering what happened? I have looked at the Superbonus scheme before but below is a basic guide.

Under the flagship Superbonus scheme launched in 2020, Italians could claim tax credits worth 110 per cent of any energy-efficiency work. ( Financial Times)

As it was tax credits Italy argued that it was not really spending and that is before where we get to where the money actually went.

Next Generation Fiscal Boost

There was also this juicing the Italian economy.

The Italian recovery and resilience plan includes a wide range of investment and reform measures in six thematic areas (the so-called “Missions”). The plan will be supported by €191.6 billion, €69 billion in grants and €122.6 billion in loans, 13% of which (€9 billion in grants and €15.9 billion in loans) was disbursed to Italy in pre-financing on 13 August 2021. Moreover, a first payment worth €21 billion was disbursed to Italy on 13 April 2022. ( European Commission)

That continues but the picture is changing with even the economics editor of The Economist tweeting this.

After receiving an eye-watering amount of money from Northern European taxpayers and blowing it (and more) on an insane green renovation scheme, austerity is coming back to #Italy. ( @COdendahl )

I think that the relevant point here is that even The Economist can find nothing to praise in a project by its prized European project.

The Economy

Let us start with the European version of Fantasy Island.

The fiscal gap next year is, however, seen below 4% of GDP under current trends. ( Reuters)

Here in a way the Italian government is agreeing with ECB President Lagarde who also said this on Monday.

Looking further ahead, economic momentum is expected to pick up as consumer spending and real incomes rise, supported by falling inflation, rising wages and a strong labour market.

I wonder if anyone laughed?

If we now return to reality we know that in the second quarter the GDP of Italy fell by 0.4% and this morning we were told this.

In September 2023, the consumer confidence index declined from 106.5 to 105.4……..With reference to the business confidence climate, the index (IESI, Istat Economic Sentiment Indicator) confirmed its decrease, moving down from 106.7 to 104.9. ( ISTAT)

Looking back the consumer confidence number has merely lost its apparent summer bounce it is the business numbers which have been trending lower.If we look at the August monthly bulletin this is another decline and it already thought this.

On the supply side, negative signals are coming from the manufacturing sector. In July, the industrial
production index, decreased by 0.7% with respect to June, after two months of increases in a row.

Also it had already picked up a turn for the worse in the labour market.

For the first time in 2023, labour market conditions worsened. In July the number of employed people fell, remaining
higher than July 2022 levels, while unemployed and inactive persons increased. In the same month, the
unemployment rate increased to 7.6%. and estimates for seasonally adjusted index of value sales grew by 0.4% in
the month on month series and volume dropped by 0.2%

The S&P Global PMI business survey suggests a 0.4% decline for Euro area GDP this quarter although it did hint that things were better outside of France and Germany.

The rest of the eurozone saw business activity remain broadly stable in September. Although manufacturing output decreased for the sixth month running, the fall was the softest since April. Meanwhile, services activity increased slightly, and to a greater extent than in August.

It goes without saying that this is also a risk for this winter.

European natural gas prices advanced as outages continued to weigh on fuel flows while the region’s heating season approaches.The benchmark contract for October delivery added as much as 4.2% on its last trading day before expiry, after gaining about 15% this month.  ( Bloomberg)

Comment

As you can see Italy is being squeezed from several directions at once and that is why its bond yields have come under pressure. An additional factor is the lack of support from the ECB and Bank of Italy who were previously hoovering up the supply. Now they only have some rebalancing within the PEPP portfolio to deploy. Also they have the issue that on a marked to market basis the 721 billion Euro holdings of the Bank of Italy must look absolutely awful. As a rough guide all the buying pushed the BTP future above 155 as opposed to the 109 this morning. Plus there is the issue of paying 4% ( the ECB Deposit Rate) on bonds you bought with a negative yield.

So at times like this you get a type of contagion which is why the ten-year yield which I noted was 4.8% as I started this piece has touched 4.9% in the meantime. As Hard-Fi put it.

Pressure, pressure, pressure pressure pressure
Feel the pressure
Pressure, pressure, pressure pressure pressure

If this was the UK then the IMF would have waded in as we see its biases in plain light.

Italy is a lovely country so let me end with some news which will help the debt to GDP ratio if not the present outlook.

As regards 2021, the new estimates resulted in a significance upward revision of GDP at market prices,
amounting to 34,670 million euro at current prices. Upward revisions occurred for the rate of change of GDP
in volume, from 7.0 to 8.3%