How Long Can Italy Hide Behind Spain?

Italy replaced Berlusconi with a technocrat prime minister: an ex Goldman Sachs banker: Mario Monti. Monti has been quite successful in following the austerity path: the Italian parliament approved many reforms. Monti also took the time to criticize Spain.

The big achievement is that Italy’s yields are lower than Spain. Apart from that, the situation is worsening:

• Yields are still high – a recent auction of 10 year notes resulted in yields above 6%. Where are the fruits of austerity?
• Fast contraction: Italy’s economy squeezed by 0.8% in Q1, far worse than the European average of 0%.
• The unemployment rate leaped above 10%.
• Purchasing managers’ indicators, which are forward looking figures, are falling.

The debt to GDP ratio of Italy isn’t much better than Greece’s: around 120%. Italy is the euro-zone’s third largest economy. If Spain is too big to bail and there are doubts if the euro-zone could survive without Spain, it’s clear that there’s no euro-zone without Italy.

If Italy gets to a point where it needs a bailout, it’s game over. So far, Italy managed to hide behind Spain. If things get worse, a comprehensive solution must include some ring-fencing for Italy.

The minimum is the renewal of the bond buying scheme by the ECB. Some debt restructuring cannot be excluded.

Italy can hope that some form of a bailout for Spain will help stabilize Italian yields as well, keeping the boot away from Italy.

This article is part of the Forex Monthly Outlook for May. You can download it by joining the newsletter in the form below, which appears on any article on  Forex Crunch.