Italian Stocks, Bonds Plunge as EU Plays Down Risk

Italian bonds plunged and the country’s stocks fell to the lowest in two years as euro-area finance chiefs failed to convince investors that the region’s second-most indebted nation will avoid following Greece, Ireland and Portugal in needing a bailout.

The yield on the country’s 10-year bond rose 41 basis points to 5.68 percent, the highest in more than a decade, while declines in lenders UniCredit SpA and Banca Sanpaolo Intesa SpA pushed the benchmark FTSE MIB index down 4 percent, the largest one-day drop in more than a year. Credit default swaps on Italy’s debt also reached a record.

European Union finance ministers rallied behind Italy before meeting in Brussels today. The nation’s 40 billion-euro ($56 billion) austerity plan to balance its budget in 2014 is “very convincing,” German Finance Minister Wolfgang Schaeuble said. “Italy can get out of this situation on its own,” added Spanish Finance Minister Elena Salgado. Both said Italy won’t need a bailout.

The Italian market meltdown overshadowed their efforts in Brussels to finish a second rescue plan for Greece aimed at ending contagion from the debt crisis. Warnings by Moody’s Investors Service and Standard & Poor’s over Italy’s ability to finance its debt, coupled with internal opposition to the government’s own budget plan, has fueled the sell-off.

Unsustainable Rates

“Over time, Italy cannot afford to pay the interest rates it is paying right now,” Andrew Bosomworth, head of portfolio management at Pacific Investment Management Co. in Munich, said in an interview on Bloomberg Television. “Its debt is unsustainable if we project into the future these sorts of interest rate levels. We do need something to change, be that a policy response or a change in attitude in the markets.”

The risk premium investors demand to hold Italian 10-year bonds over German bunds rose 57 basis points to a euro-era record 301 and has more than doubled since May 16.

At almost 120 percent of gross domestic product, Italy’s debt is the EU’s second largest by that measure after Greece. Still, the country’s 1.8 trillion euros of borrowing in nominal terms is more than the combined debt of Greece, Spain, Portugal and Ireland.

Financing Costs

The Italian government will spend about 75 billion euros, or almost 5 percent of GDP, servicing the shortfall this year and that figure is expected to rise to 85 billion euros by 2014. Jefferies International Ltd. estimates that if the average interest rate on the debt rises to 6 percent over that period rather than the 5 percent forecast, financing costs will jump by another 35 billion euros.

Italy has more than 500 billion euros of bonds maturing in the next three years. That’s about twice as much as the 256 billion euros extended to Greece, Ireland and Portugal in their three-year aid programs.

The two-day plunge in Italian stocks and bonds fueled speculation that the EU would seek to increase the size of its bailout fund in anticipation of an Italian rescue. Schaeuble dismissed a report in Germany’s Die Welt newspaper yesterday that the European Central Bank is seeking have the EU’s bailout fund doubled to 1.5 trillion euros to cover a possible crisis in Italy. “No, there can be no talk of that,” he said.

Avoiding Bubble

Until this month, Italy had avoided the worst of the fallout from the debt crisis. Its budget deficit of 4.6 percent of GDP last year was less than half the shortfalls in Greece, Spain and Ireland. The country dodged the real-estate bubble that devastated the Irish and Spanish economies.

Much of Italy’s debt is held domestically, shielding the country from some of the turbulence in international markets, and a high savings rate by households and companies also made the country’s overall debt levels seem more manageable.

Confidence in Italy has eroded in recent weeks after both Moody’s and S&P said they were reviewing their ratings as the country’s anemic growth will make it difficult to tame the debt even if the government achieves its goal of balancing the budget. Moody’s has Italy at Aa2 and last cut the rating in 1993. S&P has an A+ rating and last cut in October 2006.

Italy’s economy expanded an average 0.2 percent annually from 2001 to 2010, compared with 1.1 percent in the euro area. Growth was 0.1 percent in the first quarter, a fraction of the 0.8 percent for the euro region.

Investors have also been unnerved by opposition within Prime Minister Silvio Berlusconi’s government to the austerity plan being pushed by Finance Minister Giulio Tremonti, who is credited with containing spending and keeping the deficit under control. Berlusconi held “a long and cordial working lunch” with Tremonti on July 8, his office said in an e-mailed statement, after press reports that Tremonti was poised to resign over opposition to his budget plan.

Berlusconi and Tremonti haven’t spoken publicly since the market slide deepened on July 8, when the benchmark index slid 3.5 percent. German Chancellor Angela Merkel said she spoke with Berlusconi yesterday and has “full trust” in Italy’s ability to cut its deficit.

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