MNI INTERVIEW: Not Even QE Will Shield Italy If Targets Missed

By Silvia Marchetti

     ROME (MNI) - Even a fresh round of quantitative easing by the European

Central Bank would not be enough to shield Italy from a dangerous spike in its

bond yields if the country's recession deepens and it misses fiscal targets, the

director of the Public Accounts Observatory at Milan's Catholic University told

MNI.

     "A return to QE could maybe help but if the current economic slowdown turns

into a real heavy recession with a 1% drop in GDP there would be a systemic

country risk spike which not even more purchases of Italian securities could

avert," Carlo Cottarelli, a leading economist and former IMF official who was

briefly prime minister designate in 2018, said in an interview.

     "If Italy is perceived as a risky country by investors the spread between

German and Italian bonds would significantly rise no matter how many bonds the

central bank is willing to buy."

     ECB officials say there have been no discussions of any return to net asset

purchases, and that current forward guidance, for rates to remain unchanged

until at least 2019, is in itself accomodative, but that QE remains in the

toolbox in a severe downturn.

     Italian government bonds would continue to be eligible for any additional

asset purchases by the central bank unless they were downgraded to junk by all

four major ratings agencies, a scenario Cottarelli called "far-fetched."

     Yet, while even in a crisis the difference in yield between Italy's 10-year

bonds and Germany's would be unlikely to approach the 580 basis points seen in

2011, any spike in yields would soon force the government to adopt an emergency

budget to reassure markets and meet Brussels' requests, he said. The spread is

currently about 250 basis points.

     --DEFICIT TO RISE FURTHER IN 2020

     Cottarelli's office forecasts that Italy's fiscal deficit will hit 2.5% of

gross domestic product this year, compared to the 2.02% target agreed with the

European Commission after difficult negotiations, and that, in the absence of a

fiscal corrective plan, the shortfall will jump to 3.5% in 2020, breaching EU

rules.

     "If the government intends to stick to its target of a deficit of 1.8% of

GDP for 2020 as committed to back in December it would need to clear a

corrective, tight fiscal package of up to E35 billion, and I don't see that

happening", said Cottarelli, noting that differences with Brussels are bound to

deepen.

     The populist/far right government needs to find some E23 billion in order

to avoid an automatic spike in value-added tax next year, and another E10

billion to bring the deficit down to 1.8% of GDP. Its 2020 fiscal plan, which

will form the basis of next year's budget, must be approved by the government by

April 10.

     "The next budget law will be extremely thorny, especially as, if growth

continues to stall, it will be harder to reduce the deficit", said Cottarelli.

     "If at the end of the day fiscal commitments are not kept and clashes with

the European Commission continue, the key question is how will markets react,

what happens to the spread? One thing is certain: a 3.5% deficit is not well

perceived."

     Government sources downplayed the need for more fiscal adjustment, although

deputy Economy Minister Massimo Garavaglia of the co-governing League party did

not totally exclude it if things deteriorated significantly.

     "For the time being this is something totally off-the-wall, (there's) no

need for it. We might reconsider the situation if we ever cross that bridge," he

told MNI.

     A source linked to the League's 5-Stars Movement partners ruled-out any

tough budget tightening plan ahead: "We have no intention of backing down but

want to accelerate towards more expansive measures, cut business taxes, and

support investments and internal demand".

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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