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Monti’s Overhaul Can’t Stop Pain From Spain: Euro Credit

Italian Prime Minister Mario Monti
Mario Monti, Italy's prime minister. Photographer: Jock Fistick/Bloomberg

Prime Minister Mario Monti’s efforts to overhaul the economy and protect Italy from the region’s debt crisis may be overwhelmed by Spain’s deepening fiscal woes and the fading effect of European Central Bank three-year lending.

Monti sent parliament a plan last week to revamp the labor markets, which represents the most ambitious of his four major legislative efforts to make the Italian economy more competitive. The draft law was greeted on April 4 by a 9 basis point increase in the country’s 10-year bond yield to 5.43 percent as Spain’s debt slumped on renewed concern the country would need a bailout.

“Monti is spreading incense around, but behind the smoke there’s a labor reform that is largely insufficient,” Alberto Mingardi, head of the Bruno Leoni research center in Turin, said by phone. “Markets are realizing that the ECB’s liquidity has just bought time for the European banking system and the problems of some countries, like Spain, are still there.”

Italian borrowing costs fell more than 2 percentage points between Monti’s appointment in November and the start of March as ECB lending and his efforts to spur an economy where growth trailed the euro-region average for a decade shored up demand for the nation’s debt. Now, Spain has revived contagion concerns after the government abandoned its deficit target, contributing to four weeks of declines for Italian bonds.

Bonds Slide

The month-long slide left the difference in the 10-year yield and comparable German debt at 390 basis points at 1:24 p.m. in Rome, up 18 basis points from April 5, which was the highest close since Feb. 16. Spanish bonds have fared worse, with 10-year rates climbing 106 basis points to 5.94 percent since Prime Minister Mariano Rajoy told European Union allies on March 2 that the country couldn’t meet its deficit commitment for this year. Spain settled on a new target of 5.3 percent of gross domestic product, up from the 4.4 previously pledged.

Monti’s announcement that he secured political support to speed the labor reform passage in parliament was overshadowed last week by Rajoy who fueled bailout concern when he said April 4 that Spain was in a situation of “extreme difficulty.”

Spain dragged Italian bonds lower when demand for Spanish debt slumped at an auction the same day, forcing the government to pay 4.3 percent on five-year securities, almost 1 percentage point more than in March.

Investors will be watching to see whether last week’s Spanish offering drives Italian borrowing costs higher when the Treasury sells 11 billion euros ($14.4 billion) of bills tomorrow, followed by as much as 5 billion euros of bonds the next day.

Asia Swing

Monti said March 28 during a trip to Asia that the euro-region’s debt crisis was “almost over” after EU leaders agreed to boost the region’s bailout mechanisms. He then returned to Italy last week to face rising bond yields and growing political and popular dissent against his labor market reform.

Discontent has been rising among Italians as Monti’s efforts to balance the budget have brought higher taxes and record gasoline prices that reached almost 2 euros a liter this month. His push for companies to have more freedom to fire workers proved a hard sell with the public at a time when joblessness is at a decade high of 9.3 percent and the economy is mired in its fourth recession since 2001.

Monti was forced to back down from his original goal of allowing companies to fire workers for economic reasons without fear of reinstatement after Italy’s biggest union called for a general strike and the Democratic Party, a key political ally of Monti’s unelected government, opposed the bill.

The final draft allows for reinstatement and helped bring the Democratic Party back to the fold, virtually securing the law’s passage in parliament. The proposal also extends the country’s limited system of unemployment benefits to cover more people and limits the use of part-time contracts to encourage more permanent employment.

Senate Debate

Italy’s Senate will debate the measures this week and both houses of Parliament may offer amendments to reshape the law.

“The draft law of the labor market reform proposed by Monti’s government doesn’t represent a revolution,” Nicola Marinelli, who oversees $153 million at Glendevon King Asset Management in London, said in an interview by phone. “The real success of the government was knocking down a taboo, not changing things. The inflexibility of labor in Italy has only been scratched.”

Even after watering down the bill, Monti wins praise from economists and investors for tackling what they say are structural impediments that make it difficult to cut the euro-region’s second biggest debt of almost 2 trillion euros.

“Monti’s reforms are big step in the right direction, but they will take time to work and stimulate growth,” said Georg Grodzki, who helps oversee $515 billion as global head of credit research at Legal & General Investment Management in London. “The markets will closely watch the government’s deficit reduction progress as well as economic data. Italian government bonds are unlikely to escape unharmed if Spain’s yields keep rising.”

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