Italian political crisis makes for a soggy summer
29 May 2018
Stock markets and the euro are weak in response to the political crisis in Italy.
Britain leaving the EU is a like a walk in the park when compared to the turmoil that would be caused if a large country like Italy tried to leave the euro.
Add to all the trade uncertainties of Brexit the difficulties of creating a new Italian currency and the financial stress that would be caused by a large currency devaluation when corporate, bank and consumer debts are largely denominated in euros.
The political crisis in Italy is likely to play out over the next few months. The difference with the run up to the Brexit referendum is that a credible threat of leaving the euro pushes Italian interest rates sharply higher, as we have seen today (see chart), and this will have an economic cost if sustained. ‘Project Fear’ would be reality long before either an exit referendum in Italy or even a new general election where political manifestos included leaving the euro.
The ECB would be unlikely to buy more Italian bonds to keep interest rates low in these circumstances as central bankers would want the Italian people to understand the financial consequences of leaving the euro.
It would remain to be seen whether popular opinion in Italy would retreat from the brink of euro exit, as suspect, or whether it would dig in, blaming bankers for pushing the cost of money higher.
With global growth slowing in the background it all adds up to a soggy summer in equity markets.
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Notes to Editors:
Chart: Two year Italian government bond yield
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