(Bloomberg) -- Discontent with the European Union is nothing new in Italy. But the arrival of a populist government prepared to channel that disaffection brought fears into the open that Italy might set a course of conflict with the EU and could even tumble out the euro. A sudden panic in financial markets was brief, but worries persist of a self-fulfilling, Greek-style showdown with the EU, which could upend markets the way the U.K.’s surprise Brexit vote did in 2016. The swearing-in of Italy’s new populist prime minister ended the political uncertainty, if not the market’s sensitivity to the issue.
1. Could Italy leave the euro?
That’s highly unlikely but not entirely out of the realm of possibility. The two euroskeptic parties that took power, Five Star and the League, say they don’t want to take the country out of the euro. But they assign partial blame to the common currency for Italy having the slowest economic growth in the 19-nation euro area and an unemployment rate stuck around 11 percent. As they worked to form a government, they floated ideas like seeking a 250 billion euro ($300 billion) write-off from the European Central Bank and creating a new class of short-dated government notes specifically to pay state arrears, something critics saw as akin to issuing a parallel currency. Italy’s Democratic Party, which emerged as the biggest loser out of the March 4 vote, has accused the populists of having a hidden plan to pull the country out of the euro.
2. What spooked financial markets?
Uncertainty. Last month, President Sergio Mattarella -- whose office is traditionally regarded as a restraining influence on politics -- stepped in to prevent the appointment of a euroskeptic finance minister, sparking fears of a constitutional crisis and, perhaps, fresh elections that could further embolden anti-establishment parties or morph into some sort of de facto referendum on the euro. The subsequent collapse in government bonds was unprecedented for Italy. In two trading sessions, the yield on the country’s two-year note surged more than 2 percentage points to a high of 2.84 percent on May 29, part of a move that wiped out 66 billion euros from the value of Italian sovereign securities.
3. Do Italians want to drop the euro?
No. In a poll published on May 31, 72 percent of Italians backed the euro while 23 percent said they’d choose to leave.
4. So why the worry?
Italy could demand unworkable concessions from the EU for looser financial controls. In the view of Five Star Movement founder Beppe Grillo, the euro is not the primary cause of Italy’s economic suffering, but membership in the common currency deprives Italy of tools to respond to it. Like the U.K.’s Brexit vote to leave the EU, a euro exit could become a symbol in Italy of reclaiming national sovereignty. As Ferdinando Giugliano, a columnist for Bloomberg Opinion, wrote on May 29, "The genie of ‘Ital-exit’ is out of the bottle and it will be very hard to put it back in."
5. Why didn’t formation of a government settle the worry?
Five Star and the League enter their coalition government with plans that pose a challenge to EU fiscal rules. Those include a guaranteed "citizen’s income" for the poor and scrapping pension reform that raised the retirement age. Paolo Savona, the euroskeptic economist whose appointment as finance minister was vetoed by Mattarella, is in the cabinet after all, responsible for European affairs. Polls showed the party formerly known as Northern League, once known for deriding residents of the country’s south as beggars, thieves and good-for-nothing rednecks, gained the most support from the months of bargaining, closing in on Five Star, the web-based anti-establishment movement founded in 2009 that won the biggest share of the vote in the March election. The new prime minister, Giuseppe Conte, said on June 5 that an exit from the euro is not part of the government program.
6. Why the comparisons with Greece?
Italy’s populists, like Greece’s Syriza party that took power in 2015, have made promises to the electorate to undo EU-driven austerity measures that will inevitably put the country’s finances on an unsustainable track. Greece’s showdown with EU created the last round of existential worries about the common currency, a concern that’s receded but never gone away. The worry is that over time, Italy’s mound of debt -- which totals more than 130 percent of gross domestic product, second only to Greece’s burden of about 180 percent -- could become too expensive to finance. Still, Italy is the euro area’s third-biggest economy, not a minnow like Greece. And keep in mind that even after the spike in Italy’s two-year note yield, that’s still far lower than the 8.12 percent touched in November 2011 during the continent’s sovereign debt crisis.
The Reference Shelf
- QuickTake explainers on the euro’s existential crisis and populism.
- What the populists are promising Italy.
- A Bloomberg View editorial on what Europe should do about its Italy problem.
- Leonid Bershidsky’s column for Bloomberg Opinion explains the fury of Europe’s economically weaker countries and their gripes with Germany.
- Bloomberg Economics on the breaking point for Italy’s debt.
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