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Super Mario’s exit signals chaos ahead for Europe

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Natale Labia writes on the economy and finance. Partner and chief economist of a global investment firm, he writes in his personal capacity. MBA from Università Bocconi. Supports Juventus.

This has been a seminal week for Europe, politically and economically. The drama has played out in familiar places: the palaces of Rome and the austere Mitteleuropean skyscrapers of Frankfurt.

It was once again the turn of Italy on 20 July. Having been an unlikely bastion of stability for the past 18 months under the steady hand of respected former central banker Mario Draghi, the country was plunged back into political chaos when he resigned after the government’s unexpected collapse.

To his admirers, Draghi – or “Super Mario” – was regarded as the country’s most able and effective prime minister in generations. But it seems that no one in Italy, not even the man credited with saving the euro, can rise above the machinations of Rome.

According to popular narrative, Draghi, like Shakespeare’s Julius Caesar, was stabbed in the back by his colleagues, a victim of a right-wing plot. La Stampa cried political murder, La Repubblica led with “Italia Tradita” – Italy Betrayed.

With elections now scheduled for 25 September, the country once again faces political turmoil. With a war in Ukraine, a food and fuel crisis, soaring inflation and a looming recession, the timing could not be worse.

Read more in Daily Maverick: “Mario Draghi saved the euro, but Italian politics beat him

Cui bono? Who gains? Early indications are that Giorgia Meloni’s far-right Brothers of Italy stands to be the biggest winner, alongside its right-wing allies of Matteo Salvini’s League and Silvio Berlusconi.

Their illiberal political views are akin to those of Viktor Orbán’s Hungary. They are anti-EU, anti-immigrant, Islamophobic and hardline on LGBTQIA+ rights. 

For such ideologues, economic policy and much-needed structural reforms are an afterthought. At this critical moment, they are a threat to European unity on any number of fronts.

Eye-watering debt

Ironically, Europe’s insurance policy against a lurch to an economically destabilising right-wing government in Italy is the country’s economic fragility.

Italian debt remains eye-wateringly high, at more than 150% of GDP. Whoever takes over as prime minister will have to roll over €200-billion of maturing debt by December.

Yet, as chance would have it, the future of Italy – and indeed Europe – will perhaps be shaped more by what happened on 21 July in Frankfurt than the Eternal City.

After announcing the first interest-rate hike since 2011 – a historic half percentage point, at that – European Central Bank (ECB) governor Christine Lagarde unveiled her Transmission Protection Instrument (TPI).

Not to be confused with the test for syphilis of the same name, this scheme is designed to help any euro member state deal with “unwarranted” financial stress (read, Italy).

Should investors be seen to sell a member state’s bonds indiscriminately, they would effectively be forcing the hand of the ECB to act and intervene directly in the market, buying bonds and keeping yields down. It is an instrument designed to prevent “fragmentation” of the Eurozone.

The problem lies in the detail. Although the decision of when the ECB can intervene lies solely with the bank, TPI comes with strings attached. Eligible countries must be able to demonstrate fiscal sustaina­bility and sound macro­economic policies.

That will be tricky if Italy no longer has a credible leader, but instead a fire-and-brimstone-spouting populist.

For the moment, the market has been reassured. After aggressively selling off last week, Italian bonds have stabilised at levels last seen in the last financial crisis. The critical spread to German bunds has evened out at about 220 basis points (bps), safely below the critical 250bps seen as the danger zone.

But inflation – and the necessity of interest rate increases – is not going anywhere.

Italian bond yields are still trading higher than those of former problem child, Greece.

As the Italian political circus rumbles on into autumn, it’s likely there will come a time when the ECB’s resolve will be tested by investors.

With economically illiterate ideologues stalking Palazzo Chigi, bond investors may be looking to exploit Eurozone weakness with an assault on Italian bonds.

It is shaping up to be a stressful and volatile autumn in Europe. 

After his betrayal, Draghi will be watching from the sidelines, no doubt with a degree of schadenfreude for his erstwhile colleagues. DM

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