EU’s Rescue Gives Italy a Fillip Even If Money Takes Longer

(Bloomberg) -- Just days before the depth of Europe’s virus-induced economic plunge will be revealed, the region’s leaders may have cemented the foundations of a recovery.

The 750 billion-euro ($865 billion) stimulus agreed on Tuesday could take many months to start arriving in the continent’s worst-affected economies, but the assurance it shows to investors on the European Union’s common resolve is already aid in itself.

That message of unity gives highly indebted Italy leeway to keep tapping cheap borrowing costs to fund its own economic revival. It also protects against the damage that a renewed crisis of confidence in the euro could inflict across weaker members, and provides a fiscal reinforcement to the European Central Bank’s efforts to shore up growth.

“The announcement of the proposal has already left its mark on markets,” said Nick Kounis, an economist at ABN Amro in Amsterdam. The actual boost to economic growth is “going to be skewed to 2021, 2022 and beyond.”

The agreement by leaders follows stark warnings of the scale of the damage. The European Commission forecasts an 8.7% contraction in the 19-country euro area this year, with France, Italy and Spain expected to suffer even deeper double-digit declines.

Gross domestic product data due next week will also show governments the extent of the economic shock at the height of the crisis in the second quarter. An unprecedented slump of about 12% is anticipated.

To help the region recover from that, the new emergency fund will dole out 390 billion euros of grants and 360 billion euros of low-interest loans to vulnerable EU members. That push amounts to the bloc’s most tangible move yet toward fiscal integration.

ECB President Christine Lagarde will have a chance to comment on the deal during a Washington Post webinar at 3:15 p.m. Frankfurt time. ECB Vice President Luis de Guindos said Tuesday that the agreement shows Europe is united and will “level the possibilities” for euro-area members that lack fiscal room.

Italy, the region’s first economy to be crippled by the virus, is counting on assistance of about 209 billion euros, including 82 billion euros in grants, according to one official’s estimate.

A cabinet meeting may be held in the next few days to set up a task force for a national reform program, according to Italian newspaper la Repubblica.

But the fund’s most immediate effect is in drawing a line under the market turmoil that the pandemic reignited around the country’s membership of the euro. That was reflected in Italian 10-year bonds, whose spread over German equivalents narrowed to the least since February. The euro eased after hitting its strongest level in 18 months against the dollar. It traded 0.1% weaker at $1.1510 at 9:40 a.m. in Frankfurt.

“Its signaling effect is important,” said Marco Valli, an economist at UniCredit in Milan. “The feeling at the beginning of the crisis was that Italy was left alone, which was dangerous.”

The recovery fund itself is sizable too -- at about 5.5% of EU GDP -- and it’s been well designed, for example by incentivizing growth-friendly plans in recipient countries, Deutsche Bank AG economists including Mark Wall said in a report.

In Italy, where the agreement was lauded by front-page headlines, the stimulus will mean total spending of about 2% of GDP per year through 2026, according to Nicola Mai, head of sovereign credit research at Pimco.

Whether the euro zone’s third-biggest economy can reap the full benefit is another question. Italy has struggled to achieve much in the way of meaningful growth since the creation of the euro, a perennial weakness that made it a regular target of financial-market speculation even before this year’s turmoil.

“The problem lies with the substance and implementation: Italy structurally has not been very good at absorbing the EU budget at the local level,” said Raffaella Tenconi, chief economist at ADA Economics in London. “A lot of those funds will be wasted.”

By helping to calm market speculation, however, the fund does give the government led by Prime Minister Giuseppe Conte room to borrow for its own economic stimulus, rather than simply relying on EU handouts.

The other big factor is emergency aid by the ECB, which brought Italian bond yields under control after an initial jump in March. So even if the actual funds won’t be disbursed this year, the twin fiscal-monetary buffers are working in the country’s favor for the near term.

“The agreement reached, though indirectly, might indeed contribute to keep investors in a positive mood,” said Jacopo Ceccatelli, chief executive officer of Italian broker-dealer Marzotto SIM SpA. This could help “sustain Italy’s efforts and funding requirements in the near future.”

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