Mount Debtna

Italy's debt's become more risky

Image source: Alexandros Michailidis - Shutterstock, Wellcome Images

What's going on?

Italy’s prime minister resigned on Tuesday, and the reverberations could cause a country-wide economic crisis to erupt.

What does this mean?

Last year, Italy’s coalition government agreed to keep to European Union (EU) rules by limiting its previously high spending plans. The country’s debt is a third larger than its entire economy, and spending more than it earns in tax would’ve only added to that – and quite likely attracted EU sanctions.

But recent political machinations have put the current deputy prime minister’s party on track to take control of Italy – and he’s already promised to revive the economy with high spending and tax cuts. This could prove explosive: Italy’s economy currently isn’t growing, and if his plans don’t work, the country might not be able to repay its debts on time – or at all.

Why should I care?

For markets: Italian investors dodge lava.

Investors sold off Italian stocks and government bonds, with both having become riskier (the former still more than the latter, mind). Countries with independent central banks – like the UK and US – are able to print money to repay bondholders if they need to. But as part of the eurozone and under the European Central Bank’s jurisdiction, Italy can’t print more cash if its economy isn’t cutting muster. That puts investors in its government’s bonds at greater risk of default.

Zooming out: Japan’s between a rock and a hard place.

Recent demand for Japan’s safe haven currency and government bonds has pushed their yields down – and the yield on its 10-year bond into negative territory. This probably hasn’t gone down well with Japan’s central bank: it aims for the 10-year yield to be 0% since negative yields hurt Japanese banks’ earnings. Increasing yields by selling its government bond holdings (Japan’s central bank owns half of them) isn’t ideal either. That’d likely attract more investors, push up the yen’s value and, ultimately, make Japanese exports less appealing.

Originally posted as part of the Finimize daily email.

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