Ursula von der Leyen may have been talking about a possible budget confrontation between Brussels and Rome, but the commission president could have also been explaining why markets appear far less concerned with the election victory of far-right Giorgia Meloni than with UK chancellor Kwasi Kwarteng’s disastrous mini-budget last Friday.
“If things go in a difficult direction,” she said when asked about the Italian elections, “I’ve spoken about Hungary and Poland, we have tools.”
As sterling slumped to its lowest level against the dollar in 40 years and UK bond yields soared above Italian levels, former chief economist at the IMF, Olivier Blanchard, observed that “while we were worried about Italy, the UK sneaked in. We are lucky that the UK is not in the euro... Otherwise we would be facing another euro crisis.”
Indeed. In Dublin we concur.
Britain, courtesy of Brexit, is, needless to say, neither in the EU, nor was it ever in the euro. It is now, it says, “unconstrained” by the Brussels yoke. Had it been in the euro, however, Kwasi Kwarteng’s Friday mini-budget, involving £45 billion of debt-financed tax cuts, would have been in clear breach of euro-zone fiscal rules, the Growth and Stability Pact. In the collective interests of fellow member-states and their currency’s stability, the pact – temporarily in post-covid suspension – requires euro states, on pain of fines or financial clawbacks, progressively to cut debt levels to below 60 per cent of GDP – the UK’s budget will push its gross debt above 100 per cent to £2.4 trillion.
With no independent quantification of its likely effects, markets responded predictably, forcing interest rates through the roof and precipitating Wednesday’s huge Bank of England £65 billion rescue operation. A budget supposed to stimulate growth has instead precipitated a mortgage crisis that may stall construction and growth, and whose inflationary impact will undo all the cost-of-living concessions also provided by Kwarteng.
Britain’s distancing of itself from the constraints of EU membership has certainly given it new freedom, but a freedom, it appears, to commit economic hara-kiri. The markets, mainstream economists from left and right, and even international financial institutions such as the International Monetary Fund (IMF), have all delivered similarly damning verdicts on this piece of ideologically driven folly. The IMF’s critique, a former senior official, Eswar Prasad, says is “as close as IMF language comes to calling a set of policies irresponsible, ill-advised and ill-timed”.
Subsequent volatility in currency markets and soaring interest rates have seen comparisons of the Truss UK with an emerging market, some likening it to Sri Lanka, whose massive 2019-’22 unfunded tax cuts precipitated currency collapse and default.
A safer bet
The scale of the market jitters was reflected in increases in UK bond yield rates well past Italy’s yields, a measure of the relative appeal of lending to their respective governments. Italy, it appears, despite its own national debt running at 160 per cent of GDP, and the looming nomination of Meloni as the country’s first woman prime minister, is a safer bet.
Investors appear to feel that the constraints of EU funding rules and Italy’s desperate need for the agreed €191 billion in pandemic recovery funds will temper Meloni, who ran on a tax-cutting programme resembling that of British PM Liz Truss. EU funding is closely tied to meeting economic and structural reform targets agreed with outgoing PM Mario Draghi.
Mindful of such realities Meloni, like Truss a critic of the EU Maastricht fiscal orthodoxies, but who has clearly learned from Italian experience that a loose fiscal policy and confrontation with Brussels can only lead to higher borrowing costs and could spark a financial crisis, has been reinventing herself, ditching some of her more extravagant demands – though not the bridge to Sicily. She has pledged to observe agreed budget limits, determined to show herself a responsible steward of the economy and has hinted she will appoint a technocrat as finance minister – a Draghi Mark 2?
She advocates overhauling the scope of the recovery package and the stability pact that she says impedes Italian growth, but avoided openly endorsing the call of coalition ally Matteo Salvini to defy the commission and European Central Bank with higher public debt to pay for social spending and aid to small business. Whether a more compliant Meloni will be able to hold her right-wing coalition together is another matter.
The ECB’s willingness to use its new government bond-buying scheme to help Italy, like the BoE’s intervention on Wednesday to keep borrowing costs from spiralling, is also strictly conditional on compliance with the reform programme. The BoE has no such leverage.
As von der Leyen says of Italy, “We have tools”. But London, however, is “free” to go its own way.