Arrivederci Roma?

Italy’s brewing crisis raises fears of euro zone upheaval

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Don't get too comfortable in that seat. Source: Reuters

Italy is moving toward a full-fledged constitutional crisis, roiling financial markets as commentators in Germany and elsewhere grow more pessimistic about the future of the euro. The joint currency itself continued to lose ground, sinking to last summer’s levels, as investors fled to safe havens, including the Japanese yen.

Yields on Italian bonds continued to rise as prices dropped and the credit risk gap with German bonds widened well beyond 300 basis points, where the shift of a single basis point in the day is considered a lot. Share prices in Italy fell, with a ripple effect on other European stock markets.

The situation has revived talk of an Italian exit from the euro amid fears that populist parties, thwarted in their attempt to form a government, will increase their majority in new elections. The unprecedented decision by Italian President Sergio Mattarella to deny a coalition – with a majority in parliament – the chance to form a government is testing the constitutional limits of his power. But the populist parties forming the coalition, the Five Star Movement and Northern League, have stepped back from calling for his removal.

Even pro-European investor George Soros is sounding the alarm. “The European Union is in an existential crisis. Everything that could go wrong has gone wrong,” the legendary hedge fund manager said Tuesday at the European Council for Foreign Relations in Paris. “An existential crisis is no longer a figure of speech but the harsh reality. Europe needs to do something drastic to escape it. It needs to reinvent itself.”

“The euro is and remains a political experiment.”

Ulrich Leuchtmann, Commerzbank

News that Spanish Prime Minister Mariano Rajoy faces a confidence vote in parliament this week amid a corruption scandal only exacerbated the situation, and worries about the contagion spreading across southern Europe resurfaced, pushing up yields on Spanish and Portuguese bonds as well.

“The euro is and remains a political experiment and can fail politically if the anticipated economic benefits aren’t achieved,” said Commerzbank expert Ulrich Leuchtmann. And those benefits are lagging behind expectations, he said, not least because of the euro debt crisis.

Despite its similarity to the Greek crunch a few years ago, the brewing crisis in Italy is in another dimension. Italy is a founding member of the European Union and the third-largest economy in the bloc. “It would be very questionable whether the euro could cope with the withdrawal of the third-largest economy from the euro zone,” commented Carsten Klude, investment chief at M.M. Warburg. “The crisis scenario is being played out,” said Michael Leister, director of investment strategy at Commerzbank.

Investors are questioning whether the European Central Bank – which headed off the earlier euro crisis with its famous pledge to do anything it takes to save the euro – would be willing or able to bail out an Italy in risk of default. “Investors are now apparently asking themselves whether it’s not time to rethink and turn our backs on Italy,” Mr. Leister said.

Over the weekend, Mr. Mattarella rejected the coalition’s candidate for finance minister, the 81-year-old Paolo Savona, an avowed euro-skeptic. The president then gave a mandate to former International Monetary Fund official Carlo Cottarelli, to be prime minister in a temporary technocratic government. This would delay new elections until the fall or even early next year.

Press reports Tuesday, however, suggested that Mr. Cottarelli, sure of defeat when he presents his cabinet to parliament for the required vote of confidence, has delayed formation of a government and may give back the president’s mandate. This would force a snap election in July, with the populist coalition hoping to expand their parliamentary majority.

The Northern League support in opinion polls has risen to 25 percent from 17 percent in the March election, while the Five Star Movement remains steady at about 30 percent. The two parties are even talking about forming an alliance for the election.

All this only feeds the growing anxiety in financial markets. “Many Anglo-Saxon investors now are again looking at Europe skeptically,” said Marc Hellingrath, head of equities at Union Investment. “The problems in Italy and Spain awaken memories of the euro crisis and doubts that Europe is getting its problems under control.”

Several Handelsblatt reporters contributed to this report. Darrell Delamaide is a writer and editor for Handelsblatt Global in Washington, DC. To contact the author: d.delamaide@extern.handelsblatt.com.

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