When Italy elected a bunch of rowdy populists back in March, the rest of the eurozone assumed (or at least hoped) that the weight of responsibility would bring Rome back into line. But so far the Italians appear to be serious about ending austerity and forcing the ECB to finance their spending ambitions. The just-passed Italian budget calls for a rising deficit, in direct disobedience of Continental (read German) authorities.
Now everyone involved is staring at some hard questions.
First, the European Central Bank – which for the past few years has bought up pretty much all the bonds issued by the Italian government at ridiculously low interest rates, thus allowing Italy to shamble along as a kind of sovereign zombie – stopped buying so many Italian bonds after the election in order to show Rome that actions have consequences.
As a result, the Italians have had to find other buyers for their debt, and the rates they’ve had to pay have soared. The 10-year bond yield, for example, has spiked from less than 1.8% in May to over 3% today.
That means Italy’s interest expense is set to rise by at least one-third and probably quite a bit more going forward. This cost will be added to its already growing deficits, leading to more borrowing and higher interest expense, and so on, until rating agencies assign the government a junk rating. At which point everything falls apart. Here’s Goldman Sachs’ take:
