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Ionian islands (Colin Paterson)
Ionian islands (Colin Paterson)

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Italy's troubles mount Italy is sinking deeper by the day, and its bond yields spiking ever higher. So much so that its president was forced to pledge today that Prime Minister Silvio Berlusconi will indeed leave office soon. Honest, he will.

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Mr. Berlusconi may be planning to step down, but it's a promise that buoyed investors only for a short time. Global stock markets plunged today, and the yield on Italy's 10-year bond spiked to a crisis level well above 7 per cent at one point, raising troubling questions about the outlook for the latest country in the eye of the euro debt storm.

"Wednesday’s surge in Italian government bond yields has catapulted the euro zone crisis into a dangerous new phase," warned John Higgins of Capital Economics.

"Precedents set by Greece and Ireland suggest the Rubicon may have been crossed," he said in a report today.

"If so, Italy’s cost of borrowing could now climb much more sharply, effectively locking her out of the capital markets. Even though Italy runs a primary surplus, this outcome could still force her to turn to official creditors to roll over her debt. But while Italy is considered to be too big to fail, she may be too big to save unless there is a major change of attitude towards resolving the crisis. Things could be about to turn very ugly."

Is Italy the next Greece? Not yet. It's the fear at play, the speed at which these things are moving, and the pounding in the bond market. And there are pressures on the horizon.

"Berlusconi the billionaire may be on his way out but he’s not taking any of the €1.6-trillion in debt (120 per cent of GDP) with him," said Stewart Hall, senior fixed income and currency strategist at RBC Dominion Securities in Toronto.

"With pretty much the entire Italian government curve trading through 7 per cent, Italian yields have now pushed into a murky area of the yield spectrum that is being associated with insolvency. Simply put, the yield curve is getting in the face of policy makers striving to cut program spending as a means of arresting the fiscal deficit just as the cost of rolling over the stock of debt is eroding those very savings."

Italy's debt profile over the next two years is "troublesome," Mr. Hall noted. Next year, it needs to roll over almost €200-billion in bonds, followed by a further €150-billion in 2013. Tomorrow it faces something of a "litmus test" with €5-billion auction of one-year bills.

Concerns over Italy hammered financial markets, roiling stocks, currencies and commodities. There had been some brief optimism after Mr. Berlusconi, who lost his parliamentary majority yesterday, said he would step down when the country's austerity measures are passed.

Tokyo's Nikkei gained 1.2 per cent, and Hong Kong's Hang Seng 1.7 per cent, but stocks plunged across Europe. London's FTSE 100, Germany's DAX and the Paris CAC 40 were down in the 2-per-cent range and North American markets picked up the sentiment.

The S&P 500 and Toronto's S&P/TSX composite sank, by 3.7 per cent and 2.7 per cent, respectively. The euro fell sharply, as did the Canadian dollar as the U.S. greenback climbed.

"The worry now is that Italy’s borrowing costs in the market will rise at a more alarming rate," said Mr. Higgins of Capital Economiics. "... Within a month of the 10-year yield in Greece hitting 7 per cent in April, 2010 (the yield had very fleetingly broken above this level in January of the same year), it had reached 12 per cent, prompting Greece’s first bailout package. And within a month of the 10-year yield in Ireland hitting 7 per cent in November, 2010, it had risen above 9 per cent, triggering that country’s bailout. Only the example of Portugal offers limited hope for Italy. There yields hit 7 per cent in November, 2010, but did not move decisively higher until the early spring of this year, eventually prompting a bailout in May."

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