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CRISIS IN ITALY

Italy close to losing investors' trust: BOI

Fears of repeat elections cause investors to dump Italian bonds in biggest one-day leap in rates in 30 years

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Mr Cottarelli attending a news conference at the Quirinale Palace in Rome on May 28. He's been asked to form a government on Monday.

Rome

A SPIRALLING Italian political crisis provoked a global stock market selloff on Tuesday, cut the euro cut to an 11-month low and spiked short-term borrowing costs for the government in Rome. Investors fear that repeat elections - which now seem inevitable in the euro zone's third-largest economy - may become a de-facto referendum on Italian membership of the currency bloc and the country's role in the European Union.

US stocks opened sharply lower on Tuesday as investors switched cash into perceived safe havens. The Dow Jones Industrial Average fell 146.50 points, or 0.59 per cent, at the open to 24,606.59. The S&P 500 opened lower by 16.22 points, or 0.60 per cent, at 2,705.11. The Nasdaq Composite dropped 35.34 points, or 0.48 per cent, to 7,398.51 at the opening bell.

European financial markets saw a second day of heavy selling due to fear that repeat elections - which now seem inevitable in the eurozone's third largest economy - may become a de facto referendum on Italian membership of the currency bloc.

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Italy's central bank warned on Tuesday the nation was only "a few short steps" from losing investors' confidence, as financial markets suffered the biggest selloff in years. Bank of Italy Governor Ignazio Visco raised the alarm as investors dumped Italian bonds, causing the biggest one-day leap in short-term market interest rates in almost three decades, and as the head of state sought to install a stopgap government. "We must never forget that we are only ever a few short steps away from the very serious risk of losing the irreplaceable asset of trust," he said.

President Sergio Mattarella has designated former International Monetary Fund official Carlo Cottarelli as prime minister to calm political and market turmoil, which Italy's two anti-establishment parties blame on the head of state.

Mr Cottarelli, 64, is set to announce his Cabinet on Tuesday after a meeting with the president, two days after Mr Mattarella had vetoed the two parties' choice of a eurosceptic as economy minister in their would-be coalition government.

The 5-Star Movement and the far-right League, the biggest winners from inconclusive elections in March, abandoned plans to take power after the president's move, switching immediately to election mode. The 5-Star called for him to be impeached.

The eurozone is watching the turmoil in its third-largest economy with concern: French President Emmanuel Macron defended Mr Mattarella's courage and German Chancellor Angela Merkel spoke of the need to observe rules governing the euro zone. Investors believe Mr Cottarelli will fail to pass the 2019 budget, triggering elections in the autumn when 5-Star and the League could win yet more seats. The campaign is likely to centre on the ideas of the parties' preferred economy minister, Paolo Savona, 81, who has argued for Italy to leave the euro.

A new poll by the SWG organisation showed support for the League had jumped to 27.5 per cent, up about 10 points from the March 4 elections. With support for 5-Star falling about 3 points to 29.5 per cent, the two combined would have a 57 percent majority in parliament if they decide to join forces again.

Such worries sent Italian stocks to their lowest level since July 2017, dragged down by a selloff in the shares of banks, many of which have invested heavily in the Italian government debt that is now falling sharply in value. Yields on Italian debt soared. Those on two-year bonds, the most sensitive to political upsets, were set for their biggest one-day jump in 26 years.

The continuing uncertainty in the eurozone's third-biggest economy also helped the euro tumble to fresh multi-month lows.

Bank of Italy's Mr Visco said any move to weaken the public finances could undermine confidence and years of valuable reforms. Italy's heavy debt burden could expose it to dangerous crises of confidence, he told the central bank's annual meeting. While acknowledging the selloff was very serious, he questioned its economic basis. "There are no justifications - except for emotions - for what we're seeing today on the markets," he said.

The number of investors expecting the eurozone to lose at least one member state in the coming months has increased due to the crisis in Italy, according to the Sentix research group's monthly "euro break-up" index, released on Tuesday.

Saxo Bank currency strategist John Hardy said European Central Bank president Mario Draghi might soon be required to intervene to calm markets, as he did during the euro zone debt crisis in 2012 when he promised to do "whatever it takes".

Eurozone money markets had been betting on the ECB raising interest rates from ultra-low levels mid-next year. But with economic growth slowing and worries about Italy growing, they are now pricing in just a 30 per cent chance of a modest 10 basis point rise in June 2019.

Banking sources in Rome said the only reassurance that would count for markets would be a clear and strong statement of support for the euro from League boss Matteo Salvini. So far, he has said Italy made a mistake joining the euro but during the March election campaign, he did not call for the country to exit.

Mr Cottarelli is preparing a slimmed-down Cabinet of experts with no direct links to political parties to steer Italy to elections. La Repubblica reported that economist and former Bocconi University rector Guido Tabellini was in pole position to be named economy minister.

The 5-Star is planning big street protests against the president on Saturday.

Meanwhile, Europe's bank stocks took a beating on Tuesday. According to ECB data, Italian banks held nearly 404 billion euros (S$630 billion) of sovereign debt at the end of April - some 10.8 per cent of their total assets. Eurozone banks' sovereign debt holdings are typically concentrated in domestic bonds, which leaves them exposed to nation-specific volatility. Italy has had plenty of that in recent days, with the benchmark 10-year yield surging 68 basis points to a four-year high of 3.07 per cent. Short-term yields have also rocketed, rising over 160 basis points on Tuesday morning alone in Europe.

The 5-Star and League parties denied allegations by their Democratic Party rivals that they had a plan to pull the country out of the euro if they took power.

Trading in Italy's largest banks, Intesa Sanpaolo SpA and UniCredit SpA, was suspended temporarily after both fell 5 per cent. They've both lost over 20 per cent in the last month.

Elsewhere in Europe, Germany's Deutsche Bank AG fell to its lowest in nearly two years, dipping as much as 5.7 per cent. It had 35 billion euros in credit exposure to Italy at the end of 2017, about 4 per cent of its total.

Other big decliners included Spain's Bankia SA and Banco de Sabadell SA, along with Portugal's Banco Comercial Portugues SA and Austria's Raiffeisen International AG.

Germany's top financial regulator, BaFin President Felix Hufeld, told CNBC that the risk of contagion is real and that he's "absolutely" concerned by spillovers across the eurozone. "There is always a risk of contagion between all banks," he said. REUTERS, BLOOMBERG

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