Eurozone growth goes from setback to setback with last week’s GDP number being just the latest in a long line of similar disappointments. Soft indicators have consistently overstated the strength of this year’s recovery, and the unpleasant truth is that as one country after another has swooned under the summer heat we are down to Spain as ‘last man standing’. Our leading indicators are pointing to anaemic growth ahead for much of the eurozone and Russia’s recent food sanctions on European agriculture will only add to the downturn.
This weekend’s Italian elections are provoking a good deal of commentary and fueling mounting concern about possible consequences for the European debt crisis, and in particular for the outlook for Italian sovereign spreads in the short term. We think much of this concern is misplaced, not because we don’t think there is cause for concern, but because people are getting the timing wrong.
Events of the last week have once more brought Italy back into the headlines. The decision of former Prime Minister Silvio Berlusconi to deny support to the technocratic government of Mario Monti sent alarm bells ringing in markets across the globe. But the excitement was short lived. Last Thursday Italy sold 3.5 billion euros of a new three-year bond at 2.50 percent, the lowest yield on similar-maturity debt since October 2010 and down from the 2.64 percent paid on 14 November.
Greece is in default and Ireland and Portugal are in limbo with the market pricing in a Greek outcome in both economies. However, the situation has changed in Spain and Italy and on this measure alone, the ECB’s LTRO has been successful.
Government bond yields have declined substantially in Italy on the back of ECB’s 3Y LTRO as well as the commitment of the new government to austerity. Yet, leading indicators have slumped to a post crisis lows and sustainable growth seems far away as ever.