15 June 2005

EZA 685: Italy - politics

Italy - serious undermining of SGP credability likely, further pressure on euro, widening bond spreads
De facto abandoning of stability pact brings only short term relief for Italy The commission report presented 08 Jun confirmed Italy’s persistent breach of the SGP deficit ceiling of 3% since 2003 and the likelihood of a further rise above 5% in 2006. But commissioner Joaquin Almunia’s request that Eco-Fin launch the excessive deficit procedure at its 12 Jul meeting is likely to be deflected by the Italian government, in the absence of strong peer pressure, through vague budget promises. Serious undermining of the credibility of the newly-formulated SGP a likely consequence, resulting in further pressure on the euro in the near term. In the medium term, a turn of current positive market sentiment and growing risk aversion put Italian (and Greek) assets at risk relative to other European assets.

SummaryThe void left by an undermining of the SGP in setting a credible fiscal framework and putting fiscal policy on a sustainable trend, might be filled only gradually. In the near term there are no sanctioning mechanisms in sight, but a gradual absorption of excess liquidity in the coming 12 months could contribute to a widening of bond spreads. This might be accompanied by re-emerging peer pressure, together exerting a gradual pressure on Italian national politics (likely to be a laggard in this respect). In many ways this mirroring the position of Italy in the run-up to EMU from 1995 to 1997.

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© Graham Bishop