Italy has weathered an important bond-market test of its new government's austerity measures. But Prime Minister Mario Monti warns that the European Union will have to arm its bailout fund with considerably more ammunition if it expects to regain market confidence and get the sovereign debt crisis under control.
"[Bond]auctions held yesterday and today went rather well, but the financial turbulence absolutely is not over," Mr. Monti told reporters at his year-end press conference Thursday. Italy, he said, is paying high borrowing costs that are not justified by its own financial and economic condition, but are symptomatic of wider concerns about the euro zone.
To make the market more receptive to further bond issues from Italy and other heavily indebted euro-zone members, "most of the work needs to be done in Europe," he said, calling for a "united, joint and convincing response."
Since Mr. Monti introduced a €30-billion ($40-billion) package of spending cuts and tax hikes this month, bond investors have been more willing to buy at least shorter-term Italian debt. Longer-term borrowing costs remain uncomfortably high, although yields have largely fallen below the record levels of last month.
The market absorbed €7-billion of fresh Italian debt on Thursday in maturities ranging from three to 10 years. The yield on the 2014 notes was 5.62 per cent, down sharply from 7.89 per cent at the end of November. The 10-year bond yield slid to 6.98 per cent from 7.56 per cent at the previous auction a month ago. But yields on floating-rate bonds maturing in 2018 soared to 7.42 per cent, compared with 5.59 per cent.
A day earlier, investors – mainly banks – had snapped up the treasury's full €9-billion allotment of six-month notes, at a yield of 3.25 per cent. That was about half the rate of the previous auction of short-term paper on Nov. 25.
But Italy can ill afford to keep paying rates bordering on 7 per cent or higher for longer maturities. And even at those levels, the treasury failed to reach its target of €8.5-billion Thursday. The treasury needs to raise about €450-billion in 2012 to cover maturing bonds, as well as an estimated budget shortfall of €23.6-billion. Slightly more than €90-billion worth of bonds fall due between January and April.
Mr. Monti insists his government remains on track to balance its budget in 2013, despite increasingly dire economic conditions that will only be exacerbated by the latest austerity measures.
"We believe budget discipline is essential and any mechanism that can make this discipline secure and credible is fine, as long as there is a European economic policy … that also promotes growth," he said.
Mr. Monti is counting on reforms in the labour market and service sector, along with lower fuel prices, to make the Italian economy more competitive, and points to Nordic countries as a useful guide. But planned labour and pension reforms are drawing the ire of unions and, in any case, will not come soon enough to pull the country out of its economic tailspin.
"When it comes to bleak outlooks, this surely is a word that applies to Italy at the moment," said James Nixon, co-chief euro-zone economist at Société Générale in London.
The Italian economy shrank 0.2 per cent in the third quarter, and "all the indicators point to a further contraction" in the fourth quarter, Mr. Nixon said in a note. Consumer confidence has plunged to its lowest level in 15 years, and businesses are equally gloomy about their prospects.
"I'm an economist and realize that the measures we've adopted have many negative points," said Mr. Monti, a former European Union competition commissioner. "We aren't the ones who set goals like balancing the budget in 2013. It is a goal that was accepted by the previous government" and agreed upon "with European institutions."