Arrivederci To Easy Money

Launching a preemptive strike against inflation seems to be the policy du jour for central banks. The latest--and very unexpected--attack came on Aug. 11. After Sweden's Riksbank lifted its lending rate to banks to 8%, from 7.5%, and its key money-market repurchase rate to 7.2%, from 6.92%, the Bank of Italy immediately hiked its discount rate to 7.5%, from 7%--the first rate increase since August, 1992.

For Italy, in particular, the move reflects doubts on the efforts to trim government spending. Indeed, while the BOI said rates were raised to hold back inflation and defend the lira, the rate hike was also seen as a warning by the increasingly independent central bank to the coalition of Prime Minister Silvio Berlusconi that it must cut the deficit sharply or risk even more inflation and further rate hikes.

In fact, the BOI may have had to lift rates to slow demand as well as to attract capital needed for Italy's large public borrowings. The recovery is still solid: Industrial production rose 1% in June, or 4.4% from a year ago. But inflation is climbing, partly because of rising energy costs.

Stronger growth has not helped Italy's fiscal imbalance, however. In the year ended in May, revenues were down 2.6%, while outlays had risen 6.5% (chart). For 1994, the deficit is expected to widen by about 8%, to 159 trillion lire.

The government has pledged to cut 5 billion lire from this year's budget and an additional 45 billion lire in 1995. The cuts will come from pensions, education, and health care, and smaller pay raises for public workers.

Whether these austerity measures will pass is in doubt, though. Not only are they unpopular but infighting within the ruling coalition and Berlusconi's admission that he bribed tax officials has his government on shaky ground.

Now, higher rates will add to the government's interest payments--already 9.4% of Italy's gross domestic product. Analysts estimate the latest hike adds 7.5 trillion lire yearly to interest costs, a big offset to any fiscal cuts Berlusconi may be able to implement.

For world financial markets, the mid-August moves suggest that, aside from one more cut by the German Bundesbank, monetary policy in Europe is shifting to a tighter stance. The most likely candidates for the next hike: Britain, Spain, and Denmark.

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