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Europe’s periphery spent the euro’s first decade partying hard on the back of low interest rates imported from their northern neighbours.
Not so Italy. There was little sign of La dolce vita (although plenty of bunga bunga) after the euro was adopted. Italy had the weakest economy of any developed country from the start of the euro to 2007, worse even than Japan. Since then it has had the deepest recession in the Group of Seven nations.
Italy missed the party, but still woke up with a hangover, in the form of debt of 120 per cent of gross domestic product. Mario Monti, the technocratic prime minister, is aiming to deal with the loss of confidence this debt has engendered by piling €30bn of extra austerity on the existing cuts.
Investors loved the plan. The two-year bond had its biggest rally since at least 1993, as the yield fell a full percentage point to 5.6 per cent.
As a simple reaction to the plan, this is overdone. Mr Monti wants to trim the budget deficit by an extra 1.3 per cent of GDP over three years. This is an admirable aim but hardly radical, even added to the 4 per cent of GDP already being cut.
The signal he is sending matters, but investors already knew Mr Monti would pursue austerity. The more important question of whether Italy’s people and (elected) politicians will accept it remains to be answered, at an election.
Instead, the bond rally is driven by the perception that Mr Monti’s plan will satisfy Europe. If small countries back France and Germany’s stitch-up at Friday’s summit, there will be a deal to tighten the Maastricht treaty. The European Central Bank has already hinted that it could follow up by buying more bonds – exactly what the market wants.
All this might pan out in the short term, although the Franco-German deal is less than it appears. But for Italy, austerity across Europe and what is shaping up to be a grim recession at home will make it hard to repeat its pre-euro debt-cutting trick.
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