17th November 2011
This piece quotes Neil Williams, chief economist at UK fund manager Hermes: "Markets are losing patience so they are going for the jugular, which is the core countries and not the periphery. There is convergence but it is convergence on the weakest."
The Italian Job
The particular phase of the crisis had a number of contributory factors. The ‘accidental' downgrading of French debt by S&P was certainly unhelpful. But it has been Italy's political machinations that have been most damaging.
Italy's debt burden had previously looked sustainable, but the rise in bond yields to over 7% gives them repayment problems, especially given that political paralysis continues to prevent the passing of any austerity measures.
Azad Zangana, European economist at Schroders, says investors should not underestimate the impact on the wider economy.
"We expect debt-rating agencies to downgrade Italian debt significantly in the coming months. The downgrades combined with the falling value of Italian government debt will increase pressure on non-Italian banks to reduce their exposure, which could exacerbate the situation in the Italian bond market.
‘We are now forecasting a serious recession in 2012'
Many Eurozone banks are already on life support – unable to raise funds in capital markets and heavily reliant on liquidity from the European Central Bank.
However, this will not be enough to stop banks from deleveraging, and reducing lending to the real economy.
As a result, we are now forecasting a serious recession in the Eurozone in 2012, which is also likely to result in recessions in the wider European region, including the UK.
Zangana estimates that Italy will need to raise €275 billion in 2012 to repay maturing debt, meet interest payments and pay for public services.
He believes that given the current negative momentum, this will be a near impossible task.
Bye, Bye, Bonds
European institutional investors have been moving out of Eurozone debt since the start of 2010. For example, the Norwegian pension fund is one of the largest in the world and has moved to insulate itself from the European debt crisis.
European banks have moved much the same way. "French bank BNP Paribas led the way, announcing Thursday it had cut its total holdings of bonds issued by these five countries from 28.9 billion euros at the end of June to 16.5 billion euros at the end of October."
This trend puts even more pressure on indebted governments, making it harder to roll-over their debt.
"Politicians are the wrong people to solve this kind of problems. You need honest technocrats who are guaranteed to have their job the day after they take a big decision. Politicians do not fall in this category."
Italy now has its technocrat government. Michael Schuman on the Curious Capitalist blog believes this may have its advantages.
"As outsiders, neither is beholden to political parties or factions to the same degree as Berlusconi or Papandreou, which in theory should give them a freer hand to push through reforms. And both will enjoy at least a short honeymoon period during which the public might be willing to accept their tough decisions."
No time like tomorrow
Perhaps the biggest problem is the different time horizons between the markets and the politicians. Angela Merkel has been quoted as saying the crisis could take a decade to solve , yet capital markets want a resolution instantly.
Italy's new government may be able to effect change, but the solution to the spiral of rising debt still seems a long way off.