Commentary on Political Economy

Wednesday 28 April 2021


Mario Draghi Is Relying on Some Old Friends

With Italian bond yields inching upward, the prime minister’s economic recovery plans will depend heavily on the ECB “managing the spreads.”

The mother of all stimulus plans.
The mother of all stimulus plans. Photo: Bloomberg

Italy is at an inflection point. Not just because Prime Minister Mario Draghi unveiled the mother of all stimulus packages this week, but also because Italian bond yields are inching up to their highest levels for more than six months. The huge leap toward an economic recovery can only be achieved if the costs for the nation’s ballooning borrowing needs are kept in check.

This is where the European Central Bank, Draghi’s former employer, really has to have his back by reassuring bond markets that it will keep buying as much Italian debt as needed. This will keep the “gentlemen of the spread” — the League leader Matteo Salvini’s memorable description for bond traders — in check and ensure the differential to German Bunds remains controlled.

Hold The Line

Italian bond yields and spreads are back to February highs

Source: Bloomberg

With a bit of luck, investors might even appreciate the higher yield that Italy offers compared to the rest of Europe (bar Greece) — just as a predicted second half economic recovery kicks in. Only then can a moment of peak vulnerability pass into the rear-view mirror.

NatWest analysts reckon investors need to buy about 70 billion euros ($85 billion) of Italy’s new issues this year, net of ECB purchases. The key target is foreign purchasers, who hold only about 30% of Italy’s sovereign debt, much less than the percentage for other major European countries. But international bond buyers need to know the water is safe to enter.

Italy’s fate rests on former ECB President Draghi not only presenting a competent plan, but efficiently delivering on it — something that his prime ministerial predecessors have failed to achieve. The stakes have rarely been as high for the euro project, which depends on the future wellbeing of its third-largest economy.

The European Union’s 750 billion-euro pandemic recovery fund, of which Rome will be the leading recipient, can only do so much of the heavy lifting. Italy’s net new borrowing will be 200 billion euros this year, so it requires someone with Draghi’s reputation to instill confidence.

He can’t do that alone. His ECB replacement, Christine Lagarde, has to carry on his “whatever it takes” mantra and resist the hawkish elements on the central bank’s governing council who want to rein in its pandemic bond-buying program (PEPP) before the mission is even properly underway — let alone accomplished.

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