Italian Deadlock Rekindles Eurozone Jitters

Last Updated: 27, February 2013

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The inconclusive result of Italy’s general election has sparked concerns that one of Europe’s largest economies will have difficulty tackling its budget problems, raising the risk of a renewed flare-up in the eurozone crisis as the region’s financial turmoil is replaced by political instability.

After months of relative calm, investors and European leaders – particularly those in the single currency zone – are nervous that Rome’s politcal vacuum could paralyse outgoing Prime Minister Mario Monti’s austerity programme, returning the eurozone to where it was last July.

Tuesday’s election result left the euro zone’s third largest economy facing an extended period of political uncertainty, with the prospect of another round of elections if a government cannot be formed. In that respect, Italy is mirroring Greece, the euro zone country that sparked the region’s debt crisis.

Monti won just 10 percent of total votes, a result in itself a firm rejection of how Europe’s politicians have tackled the debt crisis so far. The austerity strategy, championed by Germany, has been to offer indebted countries financial assistance provided they agree to tough austerity.

However, some point out that the strategy has not been working, arguing that the cuts in spending have contributed to high unemployment and recession.

“This brings back all the political risk issues” that had seemed to fade from the euro zone, said Jacob Funk Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington.

European Commission President Jose Manuel Barroso on Tuesday appealed to EU leaders not to give in to populism. “I hope we are not going to follow the temptation to give in to populism because of the results in one specific member state,” Barroso said of the EU’s efforts to combat the sovereign debt crisis.

He added:

[quote] The question we have to ask ourselves is the following: should we determine our policy, our economic policy, by short-term electoral considerations or by what has to be done to put Europe back on the path to sustainable growth? For me the answer is clear. [/quote]

Financial markets reacted with alarm on Tuesday, with yields on Italian 10-year government bonds rising sharply. Global stock indices, as well as Portuguese, Spanish and Greek bond prices also fell sharply in response to the results.

In a comment, credit ratings firm Moody’s on Tuesday said that the outcome increased the risk that Italy’s structural reforms could stall or come to a complete standstill. It also noted that the strong electoral showing of euro-sceptic parties reduced the likelihood that any new elections would resolve the situation.

“Italy’s systemic importance to the euro area … means that this week’s elections have implications well beyond Italy itself and are, indirectly, credit-negative for other pressured euro area sovereigns,” Moody’s added.

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