Photo: Difei Li / Flickr
Morgan Stanley bills this weekend’s Italian elections as a “crucial risk event.”The euro crisis front has been relatively quiet since ECB President Mario Draghi gave his famous “whatever it takes to save the euro” speech in July, and many analysts have been waiting for this weekend for months.
Mario Monti, an unelected technocrat, has been relatively successful in pushing through economic reforms since assuming office in late 2011, but those reforms have driven the country deeper into recession, and record high unemployment shows how Italians are suffering.
As a result, former comedian Beppe Grillo and his newly-formed political party, the anti-establishment Five Star Movement, have seen a surge in interest.
As the elections draw nearer, the position of establishment political parties heading into the polls appears to be weakening.
The fear is that reforms could be hampered, causing Italian bond yields to rise again, causing the European chaos to reignite. Furthermore, the election shows what happens when the goals of the elites goes up against the economic situation of the voters.
With government debt topping 127 per cent of GDP, Italy is the most indebted country in the euro zone after Greece
Last week, Italy released fourth-quarter 2012 GDP figures. The economy contracted 2.7 per cent from the previous year in the Q4.
The data marked an acceleration in the pace of economic contraction from Q3, when GDP fell 2.4 per cent year on year.
Economists were expecting the numbers to get slightly better, not worse -- they had predicted a 2.2 per cent decline year on year in Q4.
Another way to see this is by looking at exports – Italy has had one of the worst recoveries in exports since 2008
Note from Deutsche Bank, source of this chart: 'This metric allows us to show over time whether a country's exports grew at a faster or slower pace than its export market. A fall in the export performance ratio implies a loss of market share.'
The main driver of this lack of competitiveness is productivity – it hasn't kept pace with wages, which means Italy's real effective exchange rate has risen much more than its peers
Deutsche Bank economist Marco Stringa wrote in a report on the Italian economy last week: 'For Italy, once again, we reach the usual finding: the priority is to increase productivity gains. In our view, that can be sustainably obtained only via structural reforms. The Monti government initiated what is only the very beginning of a structural reform process that will need to be strictly implemented (e.g. tax evasion) and expanded by the next government.'
For all that, though, government borrowing costs are at their lowest levels in three years – but continued low yields are critical for Italy if it wants to avoid economic disaster
The election has raised concerns that the economic reform programs underway in Italy – which have been encouraging low yields – could be hampered
Former comedian and anti-establishment prime-ministerial candidate Beppe Grillo has seen a surge in interest and support recently.
If his newly-formed political party, the Five-Star Movement, gains traction in parliament, it could hamper the reforms currently being pushed through in Italy.
Remember – Italy has the third-largest economy in the euro zone after Germany and France. To an extent, as goes Italy, so goes the euro zone
It also has the third-largest bond market in the entire world, behind only the United States and Japan, highlighting its systemic importance
German and French banks – the most important in the euro area and some of the largest in the world – have the biggest aggregate exposure to Italian government debt
But no one holds more Italian government debt than Italian banks themselves, many of which are classified as global systemically important financial institutions (SIFIs)
In other words, many have an interest in keeping Italian bond yields down, which means the elections in Italy this weekend are being closely watched
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