MNI INTERVIEW: Risk Factors Around Election May Weigh On BTPs

--Top Italy Observer Warns On Triple Risk Facing Rome

--Uncertain Political Outlook To Impact on Bund-BTP Spread

--Debt Sustainability Perception At Stake, Borrowing Costs Could Rise

--EU Possible Excessive Debt Procedure To Worsen Scenario

by Silvia Marchetti

     ROME (MNI) - Italy may see a pick-up in bond market tensions over political

uncertainty ahead of upcoming elections alongside the risk of higher borrowing

costs and lowered market confidence in debt sustainability, warned Paolo

Manasse, professor of Macroeconomics and International Economic Policy at the

University of Bologna.

     In an exclusive interview with Market News, Manasse argues that the next

general election, set for the spring of 2018, falls at an untimely moment amid a

series of risk factors that, if added together, could worsen Italy's outlook as

the yield spread between German bonds and Italian BTPs has already started

widening. On Thursday, the spread stood at 140bps. 

     "We're perceiving early market uncertainty, the spread has begun to edge

higher again and will continue along an upward trend if three negative factors

come together to impact on Italy's vote," said Manasse.

     First, the European Commission might decide to open a procedure for

excessive macroeconomic imbalances due to the country's elevated public debt.

Italy's 2018 budget will be given a final assessment in spring, and, despite

mixed messages sent emanating out of Brussels, many hawks in the Commission are

pushing for greater fiscal efforts from Rome.

     "Above all, the Italian government has already exploited all possible

reasons to be granted additional fiscal leeway in its adjustment path. The

commission has acknowledged flexibility for migrants and reforms so that leaves

Rome with very little space for further lobbying," said Manasse, a former OECD

and World Bank consultant who in 2011 and 2015 addressed the European parliament

on the EU sovereign debt crisis. 

     In his view, Brussels is also "losing patience over Italy's recurrent

flexibility requests" at a time when the European Central Bank is pushing for

more fiscal efforts from member states to support the ongoing economic recovery.

     However, Manasse expressed confidence that the EC will wait to see the

outcome of Italy's elections before taking any decision. Brussels wants to delay

its final evaluation of the Italian budget till after the vote "to avoid giving

a hard time to pro-European political parties" by providing populists and

anti-establishment groups with additional anti-European propaganda.

     "Brussels is aware that it is best to wait and see what happens in Italy

after the elections," rather than give a verdict beforehand, argued Manasse. 

     The second factor weighing on Italy's future is the German political

stalemate, according to Manasse. As far-fetched as this may seem, he argues,

Berlin's woes will toughen "austerity hawkish stances" and hamper any further

progress in the EU debate over granting additional fiscal leeway to member

states -- a debate which can only be Germany led. 

     "With all its troubles at home now, the last thing Berlin wants to deal

with is flexibility demands from the outside. Germany is tired of these constant

pleas, especially since it needs to work hard to build a new government at home.

It has no time to waste over flexibility calls from indebted peers like Italy so

(Rome) shouldn't expect any leniency," he said. 

     The third factor, and probably the most crucial, is tighter monetary policy

and what impact this will have on Italy's economic recovery, noted Manasse. Much

will depend on whether the recovery has evolved into longstanding structural

growth by the time the ECB starts to remove its accommodative stance.

     All these factors, when added together, have the potential of turning into

a destabilising mix for Italy. 

     "Today's uncertain political outlook and uncertainty over the government

ahead, topped with a less expansive monetary policy, with the possibility of a

EU excessive debt procedure and rising German woes might boost again financial

tensions in Italy and lead to a significant spread rise," warned Manasse.

     Such a "worrying scenario" would translate into higher debt interest rates

for Italy, roughly E20 billions in the long run, rising as a debt sustainability

perception by sovereign investors lowers. The higher borrowing costs are a

similar sum to how much fiscal leeway the EC granted Rome in years, Manasse

observed. 

     The spread between German and Italian bonds has always measured the

"gravity" of Italy's outlook. Back in 2011 market confidence reached a crisis

low, with the spread peaking at a record 574 bps, triggering a government crisis

that forced then premier Silvio Berlusconi out of office.

     Even though the spread is currently far from such alarming levels, the

political instability and the risk that anti-European and populist parties may

gain power are disquieting elements. The spread rose above 200 bps earlier this

year on populist fears over the EU taking ground in Italy. 

     "Markets are very concerned how the anti-establishment 5Star Movement will

fare, an 'unknown' political entity to foreign markets. In order to reassure

markets and inspire trust, 5Star should send out a positive message straight

away by supporting crucial reforms, yet they seem to lack a concrete electoral

program and markets don't like such vagueness," said Manasse.

     According to recent polls, the 5Star Movement, currently Italy's second

largest party in parliament after the Democrats, have lost some support

recently. However, their possible victory at next elections, or being a prop to

any new government, would push the spread up, argued Manasse. 

     "Markets won't know what to expect from a group that has never ruled the

country" and was created by comic actor Beppe Grillo, a "puppeteer" who likes to

pull the strings of his party behind the scenes, Manasse said. 

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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