A man walks in front of Palazzo Chigi, the Italian Prime Ministry, in Rome on November 10, 2011.GABRIEL BOUYS
In a crucial test of its ability to avoid a bailout, Italy managed to find buyers on Thursday for €5-billion of new debt but paid a painful price to get them out the door.
Investors demanded a yield, or interest rate of 6.087 per cent on the 1-year bills, the highest since 1997 and up from the 3.57 per cent at a similar auction a month ago. The Italian treasury, however, soon took pleasure in learning that demand was strong, at two times the amount on offer.
Not immediately known was whether the European Central Bank was buying Italian in the secondary market to support the sale. There were rumours Thursday morning that the ECB was on the verge of making a market-supporting announcement.
Italy's 10-year bond yields, which soaring well above 7 per cent on Wednesday, dipped below that level on Wednesday, but still remained dangerously and unsustainably high. Italy's next test comes Nov. 14, when it is to auction 5-year debt
The Italian debt auction came as Athens and Rome struggled to form new governments and as the European Commission cut its growth forecast for 2011 and 2012 for the 17-country euro zone. "The outlook for the European economy is unfavourably gloomy," said the region's economic and monetary affairs commissioner Olli Rehn. "The EU has come to a standstill and there is a risk of a new recession.
Mr. Rehn said gross domestic product should grow by 1.5 per cent this year, down from its previous forecast of 1.6 per cent, and only 0.5 per cent next year, down from 1.8 per cent.
Some economists think the euro zone is already in recession, one that may deepen as austerity programs crunch growth and confidence evaporates as speculation about the break-up of the euro zone picks up momentum.
Mr. Rehn pleaded for Italy to form a new government quickly for fear that a political vacuum in the euro zone's third largest will send markets plummeting again.
"The first and foremost thing for Italy is to restore political stability and capacity of decision-making, and in parallel to that, as soon as possible, take firm and determined action in order to achieve fiscal targets and boost growth -enhancing structural reforms, " he said. "These are the sine qua non, these are the necessary conditions, for restoring confidence to the Italian economy."
Italian prime minister Silvio Berlusconi announced his resignation Tuesday night, after his losing his majority in a parliamentary vote on approving last year's public accounts. But he vowed to see through a law designed to ram through Italy's new austerity and economic reform measures before leaving office.
When markets went into free-fall Wednesday, pushing Italian bond yields well beyond 7 per cent, Rome came under enormous pressure to speed up the passage of the law and form a new government. On Friday, the senate, which is still controlled by Mr. Berlusconi's party will vote on the reform measures, including raising the retirement age and privatizations of state investments and companies. The lower house of parliament, the chamber of deputies, will probably follow with its own vote the following day.
As Mr. Berlusconi prepared to depart, it appeared increasingly likely that elections would be avoided in favour of the appointment of a technocrat government led by Mario Monti, the well-respected former European Union competition commissioner who was named senator-for-life Wednesday by Italian president Giorgio Napolitano.
"A technocrat government, most likely headed by Mario Monti is in our view the best and at this stage probably the only possible credible outcome," Nomura International economist Lavinia Santovetti said in a note.
Italy's potential to sink the euro zone because of its enormous €1.9-trillion in debt, equivalent to 120 per cent of GDP, sent leaders pleading for calm. U.S. president Barack Obama said "Italy isn't Greece, it's a large country and rich country," Ansa, the Italian news agency, reported. "Athens' problem is really one of solvency," while Italy's difficulty "is more one of liquidity."
The political stalemate in Athens injected another does of tension into the markets as talks to form a new government went into its fourth day, much longer than expected.
Prime minister George Papandreou resigned early in the week to make way for a new unity government that would accept terms for a new €130-billion bailout, Greece's second since last year. The government is running perilously close to running out of money.
On Thursday, Greek party leaders agreed on Lucas Papademos, a former top European Central Bank official, to head a new interim government until early elections, the president's office said.
"The president, after recommendations by political leaders who attended the meeting, has instructed Lucas Papademos to form a new government," it said in a statement after a talks between political leaders and Mr. Papademos.
The new government will implement a 130-billion-euro bailout deal agreed with the European Union and will be sworn at 1200 GMT on Friday, the presidency said
In Europe, the stock markets were essentially flat while the euro, which had plummeted against the dollar Wednesday, was up about 0.25 per cent.
With a file from Reuters
Eric Reguly