After the ECB interest rate decision: how dangerous is Italy for the euro?

Created: 07/22/2022, 16:08

Corona, Ukraine war, inflation, government crisis in Italy - the series of shocks for Europe does not end.

But what do the decisions in Rome mean for the euro?

An overview.

Frankfurt/Rome - government crisis and new elections in Rome bring back bad memories.

Is the economically closely intertwined euro zone threatened with a new debt crisis?

What gives economists some hope: Some things are different from 2012.

How important is Italy for the euro area?

Italy is the third largest euro economy after Germany and France.

"In addition to the energy shortage and disrupted supply chains, the government crisis in Italy is another serious burden for the euro area," summarizes the finance policy spokesman for the Greens in the European Parliament, Rasmus Andresen.

"The EU is at the beginning of a new economic crisis." VP chief economist Thomas Gitzel puts it in a nutshell: "The recession is rushing on."

How strongly are Italy and Germany economically intertwined?

The two euro heavyweights maintain intensive trading contacts.

In 2021, Italy was the sixth most important export market for the Federal Republic. According to data from the Federal Statistical Office, exports worth around 75.3 billion euros went to the country.

In terms of imports to Germany, Italy ranked fifth, with imports totaling a good 65.4 billion euros.

According to the Federal Foreign Office, Germany was both the most important sales market (12.8 percent of all exports) and the most important import source (16.4 percent of all imports) for Italy last year.

If there are major changes in consumption, investment or government spending in one of these economies, this can affect the situation in the other country.

Which goods and services determine exports and imports?

Important among the Italian industrial exports are machines, metal goods, cars, electronics as well as chemical and pharmaceutical products.

In addition, there are many products from agriculture and nutrition such as fruit, cheese, wine, confectionery or meat and beverage specialties.

Fashion and textiles form another group.

During the first Corona year 2020, exports in several of these categories fell.

The Coldiretti agricultural association said that the current political crisis in Italy is unlikely to affect the country's agricultural exports - but the extreme weather with drought and fires will.

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For its part, Italy also imports many industrial products or supplies of components or materials that go into them.

Energy, plastics, vehicles, textiles and food also have larger shares.

And, of course, the country is one of the most popular holiday destinations for German tourists, which brings in billions in revenue for hotels and restaurants during the holiday season.

There is great concern that the government crisis in Italy poses a threat to the euro.

© Christian Ohde/dpa

What is the role of Italian mechanical and automotive engineering?

The heart of both sectors beats in the north, where numerous, often highly specialized machine and plant manufacturers are at home.

They sell their products all over the world - many of them also to Germany, in the car business around a fifth.

The ruptured supply chains at the beginning of the pandemic caused problems for the industry, not least because supplies from northern Italy were stagnant.

At the time, the German metal and rubber industry appealed to politicians to work towards a more stable supply after the then Prime Minister Giuseppe Conte ordered all non-essential production activities to be shut down at the height of the first wave of the virus.

It was also about supplies for medical technology such as ventilators.

Northern Italy is also the region with the most German direct investments in the country.

In 2019, their portfolio was over 40 billion euros.

Conversely, car manufacturers such as the Stellantis Group - including Fiat, Lancia, Alfa Romeo and Maserati - are customers of German suppliers.

Is the Italian crisis leading to a new euro debt crisis?

In the summer of 2012, the euro zone was on the brink.

Players on the global financial markets had lost confidence in the debt sustainability of many countries.

Interest rates on government bonds in Italy, for example, shot up and speculators bet on the euro crash.

In the past few weeks, capital market interest rates in southern Europe have again risen significantly.

The yield gap - the spread - between German government bonds and those of more heavily indebted euro countries widened.

That means: For countries like Italy it will be more expensive to get fresh money.

The European Central Bank (ECB) was forced to hold an extraordinary meeting in mid-June to calm the situation.

What is different today than in the summer of 2012?

"Economically, there is no threat of a new debt crisis," says Carsten Brzeski, chief economist at ING Germany.

"All countries, including Italy, have used the last few years to reduce interest payments." In addition, Europe is much better prepared today, says Brzeski, referring, among other things, to the ESM euro rescue package.

Ifo President Clemens Fuest sees it similarly: The euro zone has “gained in resilience through reforms such as the steps taken towards banking union”.

But Fuest warns: "Nevertheless, we are currently seeing developments that are known from the time of the euro crisis, above all increasing risk premiums on Italian government bonds."

The economists at the Deutsche Bank fund subsidiary DWS recall: The euro debt crisis of 2012 “ruthlessly revealed the unfinished construction of the common currency”.

Even today, the euro zone resembles "less an integrated currency area than a regime of fixed exchange rates, with a common currency, but individual economic and fiscal policies and fragmented labor or banking markets".

What can the European Central Bank do?

In the summer of 2012, the then President of the ECB, Mario Draghi, put his foot down: "The ECB will do everything to save the euro," promised the Italian ("Whatever it takes").

A little later, the central bank agreed to purchase unlimited amounts of bonds from euro crisis countries if necessary via the new OMT purchase program - provided the country in question meets strict reform requirements.

The determination of the monetary authorities alone calmed the financial markets.

A similar calculation seems to be behind the TPI aid program that has now been decided.

With this, the ECB wants to intervene by buying bonds if necessary, should speculators drive up the interest rates on securities of a euro state disproportionately in their opinion.

States no longer have to offer such high interest rates on the market if the ECB appears as a big buyer.

"The ECB has enough funds to fend off speculative capital movements," Dekabank chief economist Ulrich Kater is convinced.

However, the TPI urgently needs to be supplemented with political measures.

“This can only be a correction of the debt policy in the country concerned.

These issues are not to be decided in Frankfurt, but in Brussels and in the capitals of the member states."