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Tuesday, August 2, 2011

Italy in eye of the storm as cash runs low

Fears of a double-dip downturn on both sides of the Atlantic have set off fresh mayhem in Southern European bond markets, dashing hopes that Europe's summit deal in late July would contain the escalating crisis.


Italy's 10-year yields spiked through 6pc in wild trading and hit a record post-EMU spread over German Bunds, snuffing out a brief relief rally following Washington's debt deal. Spain's yields once again flirted with danger at 6.2pc.

"The markets know that the EU's bail-out find (EFSF) won't be able to buy Italian and Spanish bonds on the secondary market for another three or four months because the deal has to be ratified by national parliaments," said David Owen from Jefferies Fixed Income.

The summit accord did not increase the EFSF's firepower above €440bn (£380bn), leaving it unclear how EU leaders expect to cope as contagion engulfs the eurozone's bigger players. The fund has just €275bn left after pledges to Greece, Ireland, and Portugal. City analysts say it may take €2 trillion and a clearer German commitment to halt the panic.

"The longer this paralysis goes on, the more investors fear a break-up scenario where the core countries pull out and leave the rest with the euro," Mr Owen said.

JP Morgan warned clients that Italy has a thin margin of safety and risks running out of cash to cover spending as soon as September. "Italy and Spain will run out of cash in September and February respectively, if they lose access to funding markets," said the bank's fixed income team of Pavan Wadhwa and Gianluca Salford. Worries about Italy's immediate cash level risks leading to "a self-fulfilling negative spiral."

While Italy has low private debt and avoided much of the credit bubble, it suffers from economic stagnation and a steady loss of competitiveness. Monetary tightening by the European Central Bank has compounded the problem, triggering a collapse of all key measures of the Italian money supply.

The warning came as the eurozone's PMI manufacturing data for July dropped to a 21-month low, with clear signs of a slowdown spreading to Germany, Austria and Holland.

"It makes pretty dismal reading," said Howard Archer from IHS Global Insight. "It points to a marked loss of momentum in the previously healthily expanding core northern eurozone economies, as well as deepening growth problems in the struggling southern periphery."

JP Morgan said Italy had €44bn in liquidity for government operations at the end of May. It did not follow other countries in "front-loading" debt auctions while the going was good.

Spain is fully-funded until next year, but its fate may hang on what happens in Italy. "We believe the fate of the two countries is linked. It is very hard to imagine only one of the two losing market access," said the report.

Martin van Vliet from ING said Spanish borrowing costs are just 80 basis points shy of the level that "could cause margin requirements at central clearing houses", creating risks for Spanish banks that rely on €100bn in foreign repo financing.

The Milan and Madrid bourses both suffered a black Monday, led by bank shares. Intesa Sanpaolo slid 7pc and is now down almost 40pc since March. Unicredit and Fiat were both suspended briefly.

The manufacturing index for Spain fell yet further below the contraction line to 45.7. "There are high chances the economy has again entered recession," said Luigi Speranza from BNP Paribas.

The Internaional Monetary Fund said last week that Spain "is not out of the danger zone" and needs to take urgent measures to stave off contagion. "The outlook is difficult and the risks elevated. Risks are tilted to the downside and potentially severe. Many of the imbalances and structural weaknesses accumulated during the boom remain to be fully addressed," it said.

Spain's exports are holding up well and the budget deficit has been slashed in half. However, the fund warned that Spain's debt profile is sensitive to "growth shocks" and rising interest rates. Each 40 basis point rise in funding costs would raise Spain's public debt by a further 14pc of GDP over the next five years, and a 0.6pc erosion of growth would add a further 7pc.

Critics have warned that austerity measures may abort recovery and short-circuit any improvement in public accounts, echoing the debate underway in Britain and other countries.
The Telegraph
http://www.telegraph.co.uk/finance/economics/8675928/Italy-in-eye-of-the-storm-as-cash-runs-low.html


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