Brexit, Italexit, what about Gerexit?

The Bank of England upgraded its growth and inflation expectations for 2017, they now forecast the economy to grow at 2% this year, close to where the Bank originally forecast ahead of the Brexit vote. Despite this more optimistic expectation of economic growth and inflation the members of the Monetary Policy Committee voted 9-0 to keep rates where they are. One must wonder if Mr McCafferty, the Bank’s perennial hawk, missed the meeting. Ever since early 2011 Mr McCafferty has been, from time to time, the lone wolf voice for a rate rise. Now when the timing seems more appropriate he is strangely silent on the subject.

Whilst the focus appears to have been on Brexit and Trump, there are signs that tensions are once again building in Europe over the currency. The starting pistol may have been fired in the House of Commons for Brexit, is it about to be fired for Italexit? The gap between the yield on Spanish and Italian debt is now approaching the wides of 2012 when Mario Draghi, at the height of the Greek debt crisis, uttered the immortal phrase “do anything it took to save the euro”. He well may be getting the opportunity to repeat the trick. The cost to insure Italian debt, measured by sovereign credit default spreads, is currently almost 6 times that of Greece. Ambrose Pritchard Evans, writing in the Telegraph, expresses the view that this time the euro has pushed Italy’s debt crisis beyond the point of no return. The crux of the article is that the optimal point for Italy to leave the euro has already passed, drawing on a report prepared by Mediobanca. From here on in, the longer Italy waits to take the plunge to reintroduce the lira the worse the position becomes.

The report paints a bleak picture of a combination of the ECB winding down its bond purchase programme, Italian banks having to sell Italian debt to meet new rules on tangible equity. Combine this with German government concerns on rising inflation within the Eurozone economy, and rising US interest rates, makes an unpleasant cocktail for the Italian economy.

Donald Trump’s administration recently criticised Germany for currency manipulation, accusing them of benefitting from the undervalued euro as an exporting economy. There can be no doubt that Germany has been a major beneficiary of the euro.  

We recorded in a recent blog one former Italian Minister put forward the idea either Germany leaves the euro or Italy must. We have often put forward the belief that the only way to save the euro was for Germany to leave. The only sensible explanation for 10 year German bunds trading with a negative yield, whilst the Dax index of leading German companies offered a yield in the region of 3%, was if Germany left the euro. Once again, the euro is finding it harder to survive with Germany in it. In the most recent Merrill Lynch Fund Manager survey, the Eurozone did not feature as one of the tail risks, the next one may paint a new picture. 

Posted on February 2, 2017 .