27 February 2014

Investors get behind Renzi

Pity poor Matteo Renzi, the Mayor of Florence who has just taken over the reins of the eurozone’s third largest economy at a crucial phase in its recovery.

​The task facing the 39-year-old, the youngest ever prime minister of Italy, is considerable. The country’s sickly economy has shrunk by seven per cent in the last five years, while industrial output is down 25 per cent.

Previous attempts by predecessors Enrico Letta and Mario Monti to drive through reforms to the economy have failed.

So what makes Renzi’s chances any better in a country where the jobless rate has slumped to its worst since the 1970s as hundreds of thousands of companies have gone out of business?

While Renzi has no popular mandate, he has won two key parliamentary votes of confidence on a ticket of slashing red tape and 'revolutionising' the economy through a radical overhaul of the tax system and labour market.

“Both areas need reforms for Italy to escape the low-growth environment in which it has been trapped for more than a decade,” says Mads Koefoed, head of macro strategy at Saxo Bank.

Investor reaction has been positive with both the 2- and 10-year government bond yields down at levels not seen since before the European sovereign debt crisis, notes Koefoed.

Tuesday’s Italian bond auctions, which sold out at a record-low level for the 2015 coupon, further confirmed the positive sentiment as Renzi distanced himself from a previous indication that Italy could increase taxes on Italian debt.

But as Koefoed points out, Italian yields have been on the slide for the last six months and the political problems have “not mattered much to bond investors”.

Political crises are everyday occurrences in Italy and it is doubtful whether the new prime minister can make a difference. “Currently the new prime minister has received plenty of support, but I remain sceptical as to whether Renzi can achieve all of his goals when ‘daily life in Italian politics’ resumes,” says Koefoed.

Like Italian bond yields, the euro seems to be relatively immune to the problems in Rome as the European Central Bank (ECB) stays cool on any further easing, for now at least.

The single currency remains supported by the continuing large trade surplus in the euro area, says Koefoed.

“Furthermore, the reluctance on the part of the ECB in introducing new easing measures and the expectation that much is needed to derail the QE tapering roadmap in the US provide support of the single currency against the US dollar and we may see a bit further upside towards the 1.40 level," he adds.

“However, euro competitiveness is being eroded by the strong euro and hence any move to the upside is probably temporary.

”Euro strength could be the biggest issue for Italy as it seeks to regain competitiveness, just as the country’s previous finance minister, Fabrizio Saccomanni, warned last year when he said it could damage recovery in the eurozone.

The ECB’s March 6th announcement will be crucial. After another month of low inflation the pressure will be on Mario Draghi to deliver. His compatriots will be hoping he does.

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