Italian contagion stokes euro zone fears

THE EURO ZONE debt crisis intensified yesterday amid the first serious signs that contagion is spreading to Italy, the currency club’s third biggest economy.

Italian bond yields, which have an inverse relationship with prices, leapt to nine-year highs and the country’s stock market and bank shares tumbled.

Worries over Italy also hit the euro, which fell nearly 1 per cent against the dollar.

Continuing problems in Rome would put the entire euro zone project in doubt, as the country is considered too large to bail out.

Ken Wattrett, chief euro zone economist at BNP Paribas, said: “The mood in the euro zone has changed for the worse this week, with increasing fears of contagion and worries that the crisis could deepen.

“The fact that policymakers cannot decide how to involve the private sector in assistance for Greece has prompted a sell-off in Italian bonds. The unstable political situation in Italy and the country’s sluggish economy have not helped.”

Domestic political tensions – with the future of Giulio Tremonti, Italy’s finance minister, apparently in doubt – have helped to undermine investor confidence in Italy.

Italian prime minister Silvio Berlusconi launched a public attack on the finance minister’s handling of the centre-right government’s proposed austerity package as relations between the two men deteriorated.

The extra premium Italy pays to borrow compared with Germany surged to a euro-era high.

Fears about how Italian banks will fare in stress tests also sparked a sell-off in Italian bank stocks, which tumbled 5.7 per cent. UniCredit plummeted 7.8 per cent and Intesa Sanpaolo fell 4.5 per cent.

The wider Italian stock market dropped 3.5 per cent, although some of the losses were due to a poor US jobs report.

Spanish, Greek and Irish bond yields also leapt, but Italy’s size makes it a far greater worry for investors.

Italy, which has one of the euro zone’s highest debt to gross domestic product ratios of 120 per cent, has the biggest bond market in the currency club and a huge interest rate bill.

With nearly €900 billion of government debt maturing over the next five years, higher yields will add to strains on its economy and push up the cost of refinancing. – Copyright The Financial Times Limited 2011