ROME — Italy’s muddled election results worried investors, raising unsettling questions about the availability of the financial safety net that has kept Europe from catastrophe for the past six months, bank officials and economists say.
That safety net is a crucial offer from the European Central Bank to buy unlimited quantities of struggling countries’ bonds. The one catch was that participating countries had to commit to austerity measures - such as spending cuts and tax increases to lower their deficits.
If there’s a clear message from the Italian elections, it’s that voters rejected austerity.
If Italy can’t - or won’t - agree to cuts and reforms to promote stronger growth, the European Central Bank can’t help.
That would leave Italy defenseless if its borrowing costs rise to unmanageable levels and into default territory. And if Italy fails, Europe can’t afford to bail it out.
A top European Central Bank official said Wednesday that any country that wants to use the crucial backstop will have to meet stiff conditions and agree to take steps to cut its deficit.
Peter Praet, the top central bank official in charge of its economic analysis and forecasts, did not mention Italy in the text of his speech in Frankfurt, Germany. But he warned that the bond-purchase shield “will only be activated in cases where the benefiting country has signed up to strict and effective conditionality,” meaning an agreement to take concrete steps to curb its financial problems.
Praet’s warning came as Italy saw its borrowing costs rise as it sold $8.5 billion of 10-year and five-year bonds. The interest yield rose to 4.83 percent from 4.17 percent a month ago for the 10-year and to 3.59 percent from 2.94 percent for the five-year.
So far, Italy’s borrowing costs have risen only moderately. But the fear is that continuing turmoil could push them toward the heights of late 2011 and early 2012- a hefty 7 percent.
The central bank bond purchase program has been given most of the credit for the easing of the eurozone debt crisis in recent months. Before the central bank offered Sept. 6 to buy unlimited amounts of government bonds issued by a struggling country, Italy and Spain faced borrowing costs that would have proved crippling in the long term. The fear was that these two big economies - the third and fourth largest among the 17 European Union countries that use the euro - would be pushed into defaulting on their debts.
No bonds have been bought under the central bank’s plan, but the mere offer reassured investors and sent borrowing costs lower for debt-plagued countries such as Italy and Spain.
“Basically investors are taking this on faith,” said Simon Tilford, chief economist at the Center for European Reform in London.
The Italian result risks undermining that faith.
The two-day election on Sunday and Monday was a rejection of the previous government of financial and economic experts led by Mario Monti. That government won support from eurozone leaders by raising taxes, cutting spending, and narrowing the deficit. But the cost to Italians has been high, with the country mired in recession and unemployment on the rise. Austerity opponents argue that cutting government spending lowers growth and makes debt ultimately harder to repay.
Pier Luigi Bersani and his center-left allies appeared on Tuesday to have won a narrow victory in the lower house of parliament, but the Senate looks to be split with no party in control. Silvio Berlusconi, the former Italian premier whose center-right coalition did better than expected, is a key player since his coalition is now the second-biggest bloc in the upper chamber.
Comic-turned-political leader Beppe Grillo, whose 5 Star Movement capitalized on a wave of voter disgust with the ruling political class, had a surprisingly strong showing.
His bloc of seats in Parliament could prove crucial in making any coalition government viable.
More than half the voters supported either Berlusconi’s or Grillo’s group - both of which campaigned against Monti’s austerity measures.
Business, Pages 25 on 02/28/2013