Italy could lose "irreplaceable asset of trust” central bank governor says

The country’s stock market extended a five-day losing streak with the spread between Italian and German bond yields - an indicator of Italy’s prospects - rising to the highest level in just over five years

Bank of Italy Governor Ignazio Visco, standing at left and seen on giant screen, in an annual speech on the state of the Italian economy, Visco said that "Italy's destiny is that of Europe," as politiShow more

Italy is always just a few steps away from the “very serious risk of losing the irreplaceable asset of trust,” Bank of Italy Governor Ignazio Visco said as a political crisis in the euro area’s third-largest economy sent debt yields soaring and bank shares tumbling.

While European rules can be debated, criticized and improved, Italy cannot disregard constitutional constraints that protect savings, balance accounts and ensure the respect of international treaties, Mr Visco said at the central bank’s annual meeting in Rome on Tuesday. “Italy’s destiny is that of Europe.”

The governor, who is also a member of the European Central Bank Governing Council, stepped into the politically sensitive debate on Italy’s future role in the euro region, as the country heads toward another election that will likely only strengthen the anti-establishment parties. The country sank further into political chaos on Sunday after President Sergio Mattarella rejected a euro-skeptic finance minister put forward by populist leaders Matteo Salvini and Luigi Di Maio in their bid to form a government together.

“Italy’s populist parties are putting the country’s finances on an unsustainable track before even having spent a single euro. If government bond yields were to rise another 100 basis points -- after having climbed by that amount over the last two and a half weeks alone -- the country’s mound of debt would over time become too expensive to finance” said David Powell of Bloomberg Economics.

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The populist leaders attacked Mr Mattarella for the collapse of their planned coalition and, suggesting an international conspiracy directed against Italy, made clear the coming campaign will focus on Europe and the euro.

“While it is to be hoped that the goals and the projects of the various political groups will be set with clarity and foresight, together with the plans to achieve them, it would not be wise to ignore financial compatibility,” Mr Visco said. “Our actions and our plans send out the signals that guide the allocation of resources at the national and global level.”

Italy’s stock market extended a five-day losing streak in Milan trading, and the spread between Italian and German bond yields -- an indicator of Italy’s prospects -- rose to the highest in just over five years. “There are no justifications, if not emotional ones, for what’s happening on the markets today,” Mr Visco said. That comment that wasn’t included in the text of his speech released by the central bank.

“International investors are concerned about the political uncertainty, but Italy’s economic fundamentals remain strong,” Intesa Sanpaolo CEO Carlo Messina said on the sidelines of the Bank of Italy event. “It’s the uncertainty related to the outlook of new elections that investors are already pricing in.”

Perceptions of a debtor can change for the worse quickly, as happened in 2012 when financial markets attacked Italy, outgoing ECB Vice President Vitor Constancio said in an interview with Germany’s Der Spiegel published on Tuesday. “Italy knows the rules. They might want to read them again carefully,” the newspaper quoted him as saying.

Mr Visco also pointed out that growth momentum remained solid and that Italy’s debt burden -- which stands at more than 130 percent of gross domestic product -- could rise when the ECB starts cutting back its expansionary policies.

The Italian economy “is gaining strength, employment continues to recover, and some of the sources of systemic risk in the banking system have been eliminated,” he said. Debt servicing costs will fall “if the tensions of the last few days subside.”

At a time of growth and with monetary policy still highly accommodative, increasing the deficit is not the answer, according to the governor, even if tweaks can be made to pensions and a guaranteed income scheme for the poor that populist parties have vowed to expand.

“The reforms introduced in the past have made spending on pensions manageable; they have also placed Italy in a favorable position by international standards,” Mr Visco said. “Any turning back would be risky.”