Will the BTP-Bund spread nightmare force the ECB to retrace its steps and churn out an instrument perhaps more convincing than the one it produced at the end of July? This is the question that Bloomberg asks himself, in analyzing the possibility that the European central bank will launch a new WhateverItTakes bazooka to reduce the risk of a sovereign debt crisis 2.0, unleashed by Italy.
To reignite the spread and BTP rate fever was the clear warning that theMoody’s rating agency launched the imminent government of Giorgia Meloni.
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The prospect of a junk Italy has KOed the BTPswhich was also affected by the indiscretions on the ECB.
The rates of 10-year BTPs thus jumped at the strongest pace since the beginning of the Covid pandemic, that is, since March 2020. The fear of the downgrade has actually caused 10-year BTP rates to rise by 30 basis points, al 4,48%. Today the BTP-Bund spread is little moved, but the focus remains on the ballast that its surge will produce on the cost of financing the Italian public debt.
In fact, spread fever has never ceased to be a topical issue. All the more reason it is now that the Meloni government is about to take office: the leader of the Brothers of Italy has so far kept a low profile, but Moody’s fear is that her government change the PNRR of the Draghi government, seen as one of the sine qua non conditions to keep Italy on the straight path of reforms.
Any changes to the PNRR would cause a high voltage between the Meloni government and the European Commission, in a situation in which there are too many doubts about the effectiveness of the spread-saving shield launched by the ECB. In the meantime, it is worth remembering that that anti-spread shield is not a tool designed ad hoc for Italy. It is not for nothing that the announcement of him – which arrived at the end of July – was unsuccessful to buffer anxiety on BTPsthanks to the government crisis, the farewell of Mario Draghi, the uncertainty for the Italian political elections of 25 September, the interest rate hikes of the various central banks, including the ECB, aimed at cooling inflation, fear always more alive than a recession in the world, the energy crisis unleashed by the war between Russia and Ukraine.
It is true that in the arsenal of the ECB there is another weapon: that of the reinvestments of the PEPP – extended until the end of 2024. But this weapon is considered by the experts of Bloomberg Economics to be insufficient: it is remembered, in fact, that, in the period between June and September, rates on ten-year BTPs jumped by 139 basis points, bringing the BTP-Bund spread to widen by 41 basis points.
This, despite the ECB, in making changes to the PEPP portfolio, has increased the BTPs it has in its belly by a value of 8.5 billion euros, reducing at the same time the holdings in German Bund of 17.3 billion.
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Italy: ‘PEPP and ECB anti-spread shield are not enough’
In short, the reinvestments of the PEPP are not enough, and the anti-fragmentation tool of the euro area TPI (precisely the BTP-saving shield) announced by Christine Lagarde on 21 July last, is not easy to activate, so cas it is certainly not that godsend that Italy and other countries with a high Eurozone debt-to-GDP ratio they were used to receiving.
Among other things, Bloomberg highlights another aspect: they could be (again) opposed to a possible activation of the BTP-saving shield. the hawkish countries of the euro area – see Germany and the Netherlands – who could argue to the ECB that the possible adoption of the TPI tool would not be appropriate at this time.
And perhaps they would be right because, from Bloomberg’s calculations, it emerges that 75% of the surge in the BTP-Bund spread is not linked to the return of fear for the end of the eurobut due to the higher expectations of new monetary tightening by the ECB, aimed at curbing the surge in inflation.
The fact is that BTP rates and the BTP-Bund spread continue to rise, and that is at stake there is the sustainability of the Italian public debt.
Will the EU ask the Meloni government to cut spending?
A way to escape al worst case scenario According to Bloomberg economists, this could be a simple announcement by the European Commission on the trust it places in the Italian paper. Brussels could reassure the markets about the sustainability of the country’s public debt: not, however, without receiving something in return. This something could be the dikat to the government (Meloni government) to cut public spending. In this case, Italy would do its part, and the ECB could be convinced to activate the anti-spread shield in its favor.
Another option could be to devalue the BTPs, practically resorting to the restructuring of the Italian public debt: but it would certainly be a shock move for the Italian banking system, besieged by the doom loop problem: in all, according to Bloomberg, Italian banks have more than 400 billion euros of public debt in their stomachs, 15% of the total: which means that any write-downs-haircuts of BTPs they would force the banks themselves to launch new recapitalization operations, or increases in capital.
Debt Mutualization: ‘Greater North Fear’
The Bloomberg article also talks about the solution of a mix of modest BTP write-downs and debt mutualisation. But just hear what she said the journalist Tobias Piller, journalist of the Frankfurter Allgemeine Zeitung in an interview with La 7.
Piller recalled that “In the European treaties there is no agreement on mutualisation of debts “, remembering bluntly that debt mutualization was (is?) “The greatest fear of the northern countries”. Then asking the following question: “Why does the German taxpayer have to pay for political promises in Italy? “ .
In concluding his reflections on Italy risk, Bloomberg finally presents the worst case scenario: “l’Italexit”.
“In the absence of support from the European institutions and in the face of the eventual rejection of a debt devaluation, the last option left would be to abandon the euro: this would entail Italy’s renunciation of using the euro and the redenomination of the Italian public debt into its own depreciated currency ”.
But Bloomberg points out that “This is an extremely unlikely outcome” (however mentioned).