ROME: The premium that Italy must pay over Spain to borrow is at its highest in two years, suggesting political risks suppressed for years by central bank largesse are coming to the fore of investor concern. Even though the borrowing costs of most euro zone countries are close to record lows thanks to the European Central Bank’s asset-purchase programme, an upcoming referendum on which the political career of Prime Minister Matteo Renzi may depend is making investors cautious around Italian government bonds.
The vote, along with Italy’s ailing banks, are blamed for the widening of the 10-year bond yield gap between Italy and southern euro zone peer Spain to its most since December 2014.
The difference in the borrowing costs of the two countries is considered a crucial measure of investor perception, given the similar economic dynamics and near-identical rating. Italy is rated Baa2/BBB-/BBB+/A and Spain Baa2/BBB+/BBB+/A. “There is a tipping point when the changes become excessive and when central bank policy becomes less effective in playing the role of volatility repression,” said Mohamed El-Erian, chief economic adviser at insurer Allianz and former CEO and co-chief investment officer at PIMCO, the world’s largest bond fund manager.
“Should the outcome of the Italian referendum go against Prime Minister Renzi, you would have to ask if we are getting closer to that point,” he told Reuters. That concern is given further weight by growing suspicion that central banks may have reached the limit of their stimulus measures. That has pushed European and U.S. bond yields higher in recent weeks.
This month, the 10-year yields gap between Italy and Spain hit 33 basis points. A year earlier, Spanish 10-year bonds yielded about 14 bps more than Italy’s. “Political risk is the main driver for this,” said John Taylor, European fixed income portfolio manager at AllianceBernstein. He added that the move was underpinned by Italy’s ailing banking sector.
“The spread is an indication that the political landscape in Europe is changing, and there is a lot of nervousness what with the Brexit vote earlier this year and ahead of the French and German elections next year as well,” he said. The French presidential election is scheduled for April and May 2017 and German federal elections are due in the autumn. Concern about Italian politics centre on a Dec. 4 referendum on proposed changes to the Italian constitution that would effectively abolish the Senate as an elected chamber and prevent it from bringing down a government via a vote of no confidence.
Renzi staked his political career on the result in happier times, but the economy is unexpectedly slowing and unemployment remains stubbornly high, polls are now even. He has stopped repeating his pledge to step down over the last two months, leaving some doubt about his intentions.
The referendum also comes in the midst of a busy calendar: one month after the U.S. elections and a week before crucial central bank meetings in the euro zone and the United States.The European Central Bank is expected to tweak the asset purchase programme, while Fed officials have dropped strong hints it will raise rates in December.
