Italian borrowing costs reached the breaking point yesterday after Italian Prime Minister Silvio Berlusconi’s promise to resign failed to raise optimism about the country’s ability to deliver on long-promised economic reforms.
Italian 10-year bond yields shot above the 7 percent level that is widely deemed unsustainable, reflecting investors’ concerns that they may not get their money back, a fear that also showed up in a jump in the cost of insuring against Italian debt default.
Portugal and Ireland were forced to seek EU-IMF bailouts when their borrowing costs reached similar levels and -clearing house -LCH Clearnet Group sounded another alarm by increasing the margin it demands on debt from the eurozone’s third-largest country, effectively raising the cost of holding its bonds.
The European Central Bank (ECB), the only effective bulwark against market attacks on the eurozone, wasted no time intervening to buy Italian bonds, traders said.
“The ECB is buying in decent sizes,” a London hedge fund investor said. “It makes you wonder how much firepower it has. It’s scary. The market was a bit naive when Berlusconi left. Now it realizes there’s a mountain to climb.”
Italy has replaced Greece at the center of the eurozone debt crisis and it is teetering on the cusp of requiring a bailout that Europe cannot afford to give.
Having lost his majority in a key parliamentary vote, Berlusconi confirmed he would resign after implementing urgent economic reforms demanded by the EU and said Italy must then hold an election, in which he would not stand.
He opposed any form of transitional or national unity government — which the opposition and many on the markets favor — and said polls were not likely until February, leaving a three-month policy vacuum in which markets could create havoc.
Even with the exit of a man who came to symbolize scandal and empty promises, it will not be easy for Italy to convince markets it can cut its huge debt, liberalize the labor market, attack tax evasion and boost productivity.
“There is no guarantee [Berlusconi’s] successor will be able to do a better job. Just keep your eyes on the Italian yield for now,” said Christian Jimenez, fund manager and president of Diamant Bleu Gestion.
Policymakers outside the eurozone kept up a chorus of pressure for more decisive action to stop the crisis spreading.
IMF Managing Director Christine Lagarde told a financial forum in Beijing that Europe’s debt crisis risked plunging the global economy into a Japan-style “lost decade” and said it was up to rich nations to shoulder the burden of restoring growth and confidence.
“Our sense is that if we do not act boldly and if we do not act together, the economy around the world runs the risk of downward spiral of uncertainty, financial instability and potential collapse of global demand ... we could run the risk of what some commentators are already calling the lost decade,” Lagarde said.
Berlusconi has reluctantly conceded that the IMF can oversee Italian reform efforts.
Eurozone finance ministers agreed on Monday on a road map for boosting the 17-nation currency bloc’s rescue fund of 440 billion euros (US$600 billion) to shield larger economies, such as Italy and Spain, from a possible Greek default, but there are doubts about the efficacy of those complex leveraging plans and with Italy’s debt totaling about 1.9 trillion euros even a larger bailout fund could struggle to cope.
Lagarde said she was hopeful that the technical details of an EU plan to boost the European Financial Stability Fund to about 1 trillion euros would be ready by next month.
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