Italy: More Trouble for the Euro Zone

Last week, Italy’s Economy Minister Giulio Tremonti, the man credited for keeping Italy from falling victim to euro zone debt contagion, passed a tough set of austerity measures to cabinet. However, the 40 billion EUR austerity package ruffled the feathers of many, including Italian Prime Minister Silvio Berlusconi himself.

Italy’s head honcho criticized the Tremonti’s proposal by saying that it is too severe. Naysayers also think that the austerity package is too vague. It only specified that spending cuts will be spread in four years, with the bulk of it taking place in 2013 and 2014.

With Italy set to conduct a general election in 2013, analysts aren’t keeping their hopes up that most of it would even get implemented. In fact, Berlusconi even said he would push for changes in the austerity package even after it was already approved by the cabinet to make it more appealing to voters rather than markets.

Berlusconi vs. Tremonti

Consequently, the growing divide between the two political hotshots made investors uneasy. As I said, market junkies give snaps to Signore Tremonti for Italy’s relatively sound balance sheet over the past three years. In 2010, the country’s budget deficit only came in at only 4.6% of its GDP and it is expected to fall further to 3.9% this year.

This is probably why many economic gurus think that Italy and the euro zone in general would be in far worse shape if the finance minister is out of the picture even if not everyone is impressed by Tremonti’s proposal.

Based on last Friday’s price action, currency traders seem to feel same way. When Italy’s political squabbles hit the airwaves, the spread between the Italian and German 10-year bonds (the premium that investors are asking for them to prefer Italy’s bonds over Germany’s) widened to 2.36%. FYI, that’s the biggest spread recorded since the euro was introduced in 2002!

And that’s just the beginning! At the start of the week Asian session traders also reacted by dragging the euro to its two-week lows against the dollar and the yen.

Why exactly are traders getting all worked up over Italy? Aren’t Portugal and Ireland in hot water too?

Well, aside from escalating fears of debt contagion, we should remember that Italy’s economy is also more than twice the size of Portugal, Ireland, and Greece combined. Italy’s debt is already projected to peak at 120% of its GDP this year, one of the largest in the euro zone. If Italy sinks, then we might see the euro plunge deeper in the charts, or even hear renewed calls for the euro’s dissolution. Yikes!

All hope is not lost though. Early yesterday a select few euro zone officials had a hastily scheduled meeting ahead of the two-day meeting of European officials in the middle of this week. Though no one gave clues on what the meeting was about, many suspect that they will talk about debt problems in Greece and Italy. Let’s just hope that they have something good to tell soon!