Monti Prescribes ‘Aspirin’ for New Year’s Debt Ache: Euro Credit

Prime Minister Mario Monti is prescribing more “aspirin” to revive an Italian economy that’s probably in a recession and tackle almost half a trillion euros in debt sales after the worst year on record for Italian bonds.

At a year-end press conference in Rome on Dec. 29, Monti pledged to ready measures to spur competition and growth in the euro region’s third-biggest economy before a meeting of European finance ministers on Jan. 23. The plan comes after he spent his first month in office enacting 30 billion euros ($39 billion) in austerity and growth measures aimed at taming Italy’s surging borrowing costs.

“Monti has taken only one aspirin, now he needs to take two,” Marc Chandler, chief currency strategist at Brown Brothers Harriman & Co. in New York, said by phone. Still, “investors are underestimating Italian resolve and European resolve to keep Italy in the monetary union” as well as “the range of tools Italy still can have with a strong leadership,” he said.

The key to the euro’s survival may lie with Italy, the region’s second-biggest debtor after Greece. The nation must repay about 130 billion euros in debt in the first quarter with its 10-year bond yield close to the 7 percent level that led Greece, Ireland and Portugal to seek bailouts. The $2.3 trillion economy probably entered a recession in the three months through December, its fourth since 2001, according to the government.

ECB Assistance

Italy sold almost 20 billion euros of debt last week with borrowing costs declining by almost half at a sale of 9 billion euros of 6-month bills. The auctions underscored how the European Central Bank is helping Italy tap markets after the Frankfurt-based institute loaned 489 billion euros to banks to ease credit.

The yield on Italy’s benchmark 10-year bond rose 4 basis points to 6.95 percent at 2:15 p.m. Rome time, pushing the difference with German securities to 506 basis points. Italy will seek to raise almost 450 billion euros in debt in 2012. Its next auction is Jan. 12.

“Yields on shorter maturities have gone down substantially, signaling that, notwithstanding the extremely serious situation of government finances, market players saw the danger of a default receding,” Marino Valensise, who oversees 51 billion euros as chief investment officer at Baring Asset Management Ltd. in London, said in an e-mail.

The yield on Italy’s 2-year bond rose four basis points to 4.73 percent at 2:17 p.m. Rome time, down from 7.66 percent on Nov. 25 when it exceeded the yield on the nation’s 10-year benchmark bond by 12 basis points. That difference indicated investors perceived a higher risk in lending to Italy for two years than for a decade.

Record Years

Italian and Greek bonds had their worst years on record in 2011 as Europe’s financial woes intensified. Greek bonds lost 63 percent through Dec. 29, the largest since at least 2000, while Italian bonds dropped 5.7 percent for the worst year since at least 1992, according to indexes compiled by Bloomberg and European Federation of Financial Analysts Societies.

While Italy’s budget deficit (EUBDITAL) last year of 4.6 percent of gross domestic product was almost half that of Spain, Spanish 10-year bonds yield about 1.7 percentage points less than equivalent-maturity Italian bonds. Monti on Dec. 29 attributed the difference to a Spanish debt stock that’s roughly half the size of Italy’s and to Spanish leaders’ ability to apply “moral suasion” on their banks to buy government securities.

“In a sibylline way, Monti declared that the Italian government intends to do the same,” Francesco Garzarelli, co- head of fixed-income strategy at Goldman Sachs Group Inc. in London, said in a Dec. 29 note to investors.

Devaluation, Inflation

Ten years after euro bank notes replaced national currencies on Jan. 1, 2002, the euro has for the first time recorded two consecutive annual losses against the U.S. dollar while plunging to a record low against the yen. A weaker euro and faster inflation may help the region’s economy to revive growth amid 1.1 trillion euros in euro-area debt sales this year, Valensise said.

“De-facto, the ECB is already printing, via the long-term loans to euro-zone banks and lowering collateral requirements,” he said. “Those who fight inflation -- the Germans -- are fighting yesterday’s battle: we desperately need some.”

Monti’s government forecasts the economy (ITPIRLQS) will shrink 0.5 percent next year. Monti said last week his new “Grow Italy” plan will also seek to boost infrastructure spending through a better use of European Union funds. Measures to overhaul the labor market will be unveiled in February.

Withstanding Costs

Italy will be able to withstand an increase in borrowing costs for at least a few years as its relatively long debt maturity helps mitigate the effects of higher bond yields, the Bank for International Settlements said in its Quarterly Report. The cost of servicing its debt would rise by just 0.95 percent of gross domestic product next year if 10-year yields stayed at the level of 7.48 percent reached on Nov. 9, it said on Dec. 11.

Under Monti and his predecessor, Silvio Berlusconi, Italy has passed deficit cuts valued at 5 percent of GDP over the next two years, according to an estimate by Goldman Sachs. A former EU commissioner, Monti has also called for increasing the resources of Europe’s rescue funds and for a region-wide economic “growth agenda” to better fight the debt crisis.

“In the medium term, I don’t see many risks because Italy has a very solid ability to pay,” Alessio de Longis, a portfolio manager at Oppenheimer Funds in New York, said in a Dec. 30 interview on “InsideTrack” on Bloomberg Television. Italy “is scheduled to easily reach a balanced budget in 2013, so it becomes more of an issue with the long end, and the long end is priced off of those structural reforms.”

To contact the reporter on this story: Lorenzo Totaro in Rome at ltotaro@bloomberg.net

To contact the editors responsible for this story: Craig Stirling at cstirling1@bloomberg.net.

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