According to data released by ISTAT on Friday, the Italian economy is decelerating; in the meantime, political risk is undermiing the recovery of the banking sector.
In July, Italy has seen exports drop and unemployment marginally increase to 10,9%. The Italian economy is the worst-performer among the G7 economies.
Investors are losing overall confidence due to increasing political risk. In the first instance, the contagion mechanism from politics to the economy the banking system.
In trading on Friday, Italian 10-year bonds broke the 3% yield barrier, closing the day at just under at 2,93%. This was possible through government intervention, as the Treasury stepped in to buy back €950 million in bills and bonds.
The surging cost of Italian debt has triggered a political crisis.
Prime Minister Giuseppe Conte summoned top ministers to discuss Italy’s 2019 budget due to be presented in October 2018. The Italian budget envisages both the introduction of two flat tax rates of 15% and 20%, as well as a lowering of the age of retirement.
Given the current growth rate, this policy would set Rome on a collision course with Brussels, as the threat Italy could return to deficits is evident. The Italian economy is the second most indebted in the Eurozone, with 131% debt-GDP ratio. At the same time, the European Central Bank has made clear that its bond-buying program will end in December 2018.
The prospect of spiralling debt-payments and an increased deficit spooks markets, which has a knock-on effect on Italy’s banking system.
Italian banks hold €380bn in government bonds. For systemic banks that struggling to restructure, such as the state-owned Monte dei Paschi, the depreciation of government bonds means a noticeable drop in core capital reserves. This also hurts share value.
Monte dei Paschi was rescued in 2017 to the cost of €8bn for the Italian taxpayer; the bank has since returned to profitability. Over the last year, Italians banks have been aggressively slashing their exposure to non-performing loans by securitizing it and selling off to investors. Now, the problem stems from the public sector.