Political uncertainty in Italy again raised market concerns. Volatility is expected at least in the near-term as Prime Minister Letta might need to find sufficient support to remain in the government. An early election of the government cannot be ruled out although the likelihood is not high. Bond investors are mostly concerned about the impact on credit ratings of Italy's sovereign bonds. With all of S&P, Moody's and Fitch putting Italy in negative outlook and ratings marginally investible, a downgrade would cause huge liquidation. Meanwhile, the potential haircut for the Italian government bonds by the ECB worsens the situation.
Silvio Berlusconi asked 5 ministers of its centre-right PDL party to resign last Friday, triggered by the government's failure to agree on budget measures needing to keep the general government budget deficit below 3% of GDP this year. The decision was described by Prime Minister Letta as “mad and irresponsible” as Berlusconi “solely finalized to cover his personal travails”. Note that Berlusconi lost a final appeal in a tax fraud case and is expected to begin a one-year prison sentence, most likely in house arrest, in mid-October. While Letta has not yet accepted the resignation, he has announced that he would ask for a vote of confidence in parliament in the next few days, possibly on Wednesday.
A number of possibilities can be expected in the consequence. With the mixed opinion about Berlusconi's call for resignation within the PDL, it might be likely that Letta would find sufficient support to retain a majority in parliament by gaining support from several PDL dissidents. If there lacks support of the parliament new government has to be formed or an early election would be carried out.
No matter which scenario materializes, market volatility is expected, at least in the near-term. Concerning the credit ratings, S&P, Moody's and Fitch assigned Italy with BBB (negative outlook) on July 9, 2013, Baa2 (negative outlook) on July 12, 2012 and BBB+ (negative outlook) on March 8, 2013 respectively. All of them stated at that time that political uncertainty was a key factor triggering the downgrade as it would affect implementation of structural reform. However, we expect the agencies would take a wait-and-see mode this time before making any adjustment. Any downgrade would strip Italy's bond off the investment grade, causing a number of funds to liquidate.
Canadian rating agency, DBRS, placed Italy at A-, with negative outlook on March 6, 2013. A downgrade would raise the cost of the Italian banks' funding at the ECB operations. In July, the ECB raised haircuts for Eurozone sovereign debt (Category I) by 0.5% to 2.5% for BBB+ to BBB- rated countries, while reducing haircuts on paper rated AAA to A- by 0.5%-1%, depending on the maturity of the bonds. Helped by the ECB's “first-best” rule, haircuts on Italian bonds are still low with DBRS' A- rating. A downgrade would put Italy's collateral into a lower category, hence raising the cost of borrowing.
Silvio Berlusconi asked 5 ministers of its centre-right PDL party to resign last Friday, triggered by the government's failure to agree on budget measures needing to keep the general government budget deficit below 3% of GDP this year. The decision was described by Prime Minister Letta as “mad and irresponsible” as Berlusconi “solely finalized to cover his personal travails”. Note that Berlusconi lost a final appeal in a tax fraud case and is expected to begin a one-year prison sentence, most likely in house arrest, in mid-October. While Letta has not yet accepted the resignation, he has announced that he would ask for a vote of confidence in parliament in the next few days, possibly on Wednesday.
A number of possibilities can be expected in the consequence. With the mixed opinion about Berlusconi's call for resignation within the PDL, it might be likely that Letta would find sufficient support to retain a majority in parliament by gaining support from several PDL dissidents. If there lacks support of the parliament new government has to be formed or an early election would be carried out.
No matter which scenario materializes, market volatility is expected, at least in the near-term. Concerning the credit ratings, S&P, Moody's and Fitch assigned Italy with BBB (negative outlook) on July 9, 2013, Baa2 (negative outlook) on July 12, 2012 and BBB+ (negative outlook) on March 8, 2013 respectively. All of them stated at that time that political uncertainty was a key factor triggering the downgrade as it would affect implementation of structural reform. However, we expect the agencies would take a wait-and-see mode this time before making any adjustment. Any downgrade would strip Italy's bond off the investment grade, causing a number of funds to liquidate.
Canadian rating agency, DBRS, placed Italy at A-, with negative outlook on March 6, 2013. A downgrade would raise the cost of the Italian banks' funding at the ECB operations. In July, the ECB raised haircuts for Eurozone sovereign debt (Category I) by 0.5% to 2.5% for BBB+ to BBB- rated countries, while reducing haircuts on paper rated AAA to A- by 0.5%-1%, depending on the maturity of the bonds. Helped by the ECB's “first-best” rule, haircuts on Italian bonds are still low with DBRS' A- rating. A downgrade would put Italy's collateral into a lower category, hence raising the cost of borrowing.
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