Italian Bond Rally Weakens Monti’s Hand With Merkel: Euro Credit

Italian Prime Minister Mario Monti
Mario Monti, Italy's prime minister. Photographer: Dani Pozo/AFP/Getty Images

Italian Prime Minister Mario Monti’s campaign for collective action to fight Europe’s debt crisis may be compromised by falling bond yields as he meets German Chancellor Angela Merkel.

Italy’s credit is as good as it has been in three months, according to a decline in 10-year bond yields. Short-term rates have fallen too. Monti’s Treasury sold six-month bills today at the lowest rate since March. That may make it easier for Merkel, who is hosting Monti in Berlin today, to sidestep the Italian premier’s proposal for the region’s rescue funds to buy bonds with the support of the European Central Bank.

“Monti’s arguments have more force when yields are spiking in spite of the fact that his government has implemented a number of credible reforms,” said Mujtaba Rahman, an analyst at Eurasia Group in New York. “It is at this moment when his argument carries more thrust with the Germans.”

Monti, 69, is on the road as European leaders prepare for the next phase of fighting a crisis that started with Greece three years ago and spread to Ireland, Portugal and Spain. Italy, which is due to sell $21 billion of debt in the next two days, still pays about 1 percentage point more to borrow for a decade than the average for the last five years. Monti said he may request bond buying to bring down funding costs, while seeking to limit any conditions the European Union would try to impose.

Monti Interview

“Certainly I don’t want Italy, after all the efforts we have made which are producing results, to be subjected to some sort of intrusive special administration like has happened with the countries that needed aid to balance their accounts,” Monti said in an interview published in Il Sole 24-Ore today. “We are not in that situation.”

The ECB, in its push to ensure price stability, retains the right to “go beyond standard monetary tools,” ECB President Mario Draghi said today in an op-ed for Germany’s Die Zeit. While the central bank will act within the limits of its mandate and defend its independence, it may take “exceptional measures” to counter “irrational fears,” Draghi said, according to the English translation posted on the ECB’s website.

Pressure Easing

Italian 10-year yields fell 3 basis points to 5.80 percent today. That compares with rates of 6.7 percent on July 25. Spanish yields of similar maturity debt gained 4 basis points to 6.52 percent, while the German rate fell 3 basis points to 1.31 percent.

The pressure on Monti has eased since July thanks to pledges of support for future EU bond-buying efforts from Draghi and the German government’s diminishing opposition to bond-market intervention by the central bank. Investors have made a total return, including reinvested interest, of 6.5 percent on Italian bonds since July 24.

“There is demand for Italian paper, but still on the very short-term part of the curve,” said Nicola Marinelli, who oversees sovereign and high-yield debt in a $160 million fund at Glendevon King Asset Management in London. “There is still the risk that the demand for bonds can collapse if we get the wrong kind of news out of Italy.” Marinelli doesn’t own Italian or Spanish government debt.

Italy sold 181-day bills at 1.585 percent today, down from 2.454 percent at the last sale of similar-maturity debt on July 27. Investors bid 1.69 times the amount of bills offered, up from 1.61 times last month.

ECB Debate

The ECB may use its funds to lower yields if Italy and Spain request such aid, Draghi has said. The central banker is expected to give details of the bond-buying plan and possibly lay out what type of conditions the ECB would demand in return when the Governing Council meets on Sept. 6. Still, Bundesbank President Jens Weidmann this week reiterated his opposition to ECB bond buying, saying in an interview with Der Spiegel that it “can become addictive like a drug.”

“Preventing the ECB from buying government bonds to address imbalances, as the Bundesbank is trying to do, could end up, particularly in the case of Germany, becoming an own-goal with paradoxical effects,” Monti said in the Sole interview referring to a soccer play who accidentally puts the ball into his own net.

Debt Load

Bringing down funding costs is critical for Italy, which has a debt of almost 2 trillion euros ($2.5 trillion), the euro-region’s second biggest in nominal terms after Germany. The Treasury still has to finance 165 billion euros of maturing bonds and bills this year, more than three times the level faced by Spain.

Italy sold 3 billion euros of zero-coupon 2014 debt yesterday to yield 3.064 percent, down from 4.86 percent at the previous auction on July 26, as investors bid for 1.95 times the amount offered, compared with 1.78 times last month. The results were “relatively good,” Annalisa Piazza, fixed-income analyst at Newedge Group in London, wrote in a note to investors.

Today’s 9 billion-euro auction of six-month bills precedes the sale of as much as 7.5 billion euros of five and 10-year bonds tomorrow.

Monti was helped in negotiations with Merkel earlier this year when advances in Italian yields prompted speculation that the 17-country euro group could break up. Merkel was persuaded at a June 28-29 meeting of euro-area leaders to allow Monti’s push to grant the region’s bailout funds more flexibility in coming to the aid of nations like Spain and Italy, who are bringing down their deficits and still facing high financing costs.

Support for Merkel has been increasing in Germany as European leaders prepare for what the chancellor called a “decisive phase” in their crisis fighting efforts. Merkel’s Christian Democratic Union and its Bavarian sister party climbed three percentage points to 39 percent, the highest since July 2008 and since the incumbent coalition was formed, according to the weekly Forsa poll for Stern magazine and broadcaster RTL published today.

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