Nouriel Roubini e Brunello Rosa , re-posted from roubini.com
- Like everybody, Germany was surprised by the Italian election; it
had hoped a coalition of the incumbent prime minister, Mario Monti, and
center-left leader, Pier Luigi Bersani, could run Italy and continue
pursuing “Plan A.” In all likelihood, such an outcome would have led to
Italy accepting painful austerity and reforms, while Germany, the core
and the ECB agreed to be patient and provide substantial fiscal
(EFSF/EFSM and now ESM) and ECB liquidity (a building up of Target 2
balances, LTROs, full allotment, SMP and now the OMT bond-buying
program) resources. The election results dashed these hopes.
At first, German policy makers decided not to make public statements about the perilousness of Italy’s position, instead
hoping that a broad coalition government could be formed, ensuring
maintenance of fiscal discipline and structural reforms. German policy
makers realized that confronting Italy publicly would be
counter-productive as it would inflame populist forces. The German
government and the dominant Christian Democrats (CDU) party also don’t
want an Italian crisis prior to the German election in the fall.
- However, in the past three weeks, Germany’s concern has escalated and a significant hardening of its position toward Italy has taken place.
First, officials at the Bundesbank—always opposed to Italy making use
of OMT—have signaled in private that there is absolutely no chance of
Italy signing a memorandum of understanding (MoU; the necessary first
step before accessing OMT) and that any easing of OMT conditionality is
unacceptable. Also, the ECB is now clearly of the view that, without a
sound Italian government that could credibly sign an MoU, there is no
way the ECB could open the OMT program for Italy; most ECB members are
committed to conditional—rather than an unconditional—OMT.
- Anyway, given the fall in the EZ inflation rate, the downside
risks to economic growth and the tail risks coming from Cyprus and
Italy, the ECB is already independently leaning in the direction of
policy easing. It is highly likely to cut the refinancing (refi) rate
soon and could even undertake additional policy easing operations, such
as some form of credit easing. This should, indirectly, help Italy.
- Contrary to the hawkish German view, the tone in Paris toward Italy is on the whole less alarmist.
That being said, the French finance ministry’s position is different to
that of the presidency at the Elysée Palace. The finance ministry is
fiscally more conservative and still hopes that some variant of Plan A
will work for Italy and for other EZ periphery members. Those closer to
President François Hollande and Prime Minister Jean-Marc Ayrault are
more concerned about Italy and the lack of a growth strategy for the
Germany now thinks Italy is lost, believing that, whatever
government is formed, it will not be able to follow policies that are
even vaguely close to Plan A. German sources have told us that, if
things go wrong in Italy (which is likely), there are only two options: Either Germany leaves the EZ or Italy leaves the EZ.
- So, an Italy-Germany confrontation seems almost inevitable. Who will blink in this game of chicken? There are three possibilities:
1. Italy makes it: Italy ends up blinking and goes back
to some variant of Plan A. German policy makers seem ready to negotiate a
tradeoff between austerity measures and structural reforms: Faster
progress on the latter might be traded for a slower pace of austerity.
2. Italy muddles through: Italy and Germany both
blink—although Germany and the ECB concede more—and find a compromise
that continues (however awkwardly) the current muddle-through approach
to the crisis. In this scenario, Germans debate whether challenging
Italy with renewed market discipline may not be a better strategy than
accommodating Italy with ECB easing.
3. Italy breaks it: After a period of brinkmanship, Germany and Italy end up on collision course. At that stage, two possibilities emerge:
Germany blinks, because the cost of an EZ breakup would be huge
for Germany and everyone else in the EZ, including the risk of the
destruction of the EU single market and the political project. Italy
gets a much easier ride (but not to the extent that the ECB buys BTPs
Germany does not blink, preventing the EZ becoming a
true transfer union where fiscal and liquidity resources are used to
backstop a large number of distressed members even if they don’t deliver
on their commitments to fiscal austerity and reforms. If Germany does
not blink, BTP-bund spreads widen sharply before a new Italian election.
The ECB has indicated to us that it would do everything possible to
ring-fence Spain, most likely via an OMT program, and, if need be, offer
further support to current program countries.
To read the full analysis, visit roubini.com.