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bond market heats up amid ECB tightening and political divide

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An Italian Special Air Force aircraft unit spreads smoke in the colors of the Italian flag above Rome.

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An eventual result in Italy’s presidential electionsWhile political stability may not have been avoided, the market observers are concerned about Europe’s largest economy and its economic future.

The yield of the Italian 10-year government bond traded at 1.8680% late Tuesday afternoon — up around 5 basis points and building on the gains seen Monday. The rate on the benchmark bond is at its highest since April 2020, meaning the Italian government is now facing higher costs when raising funds from public markets — which could ultimately become an economic headache for Rome.

“The reality is that there will be no ECB QE in the future, and peripheral bond markets must adapt to this fact. [quantitative easing]Pictet Wealth Management strategist Frederik Ducrozet stated in Tuesday’s note that “I believe so.”

One reason for this week’s moves in European debt markets is the increased expectation that the European Central BankMonetary policy could be tightened in 2022 with the possibility of a further increase. rate rise later this year. Any rate hike would be the first since 2011The bank was also criticized in moving too early in a time of great financial stress.

Since 2011, the 19-nation euro zone (of which Italy is part) has had a loose monetary policy. It received billions to boost lending and stimulate economic activity. The 2019 crisis shattered the regional’s optimistic outlook. coronavirusThe ECB initiated a bond-buying program in response to the pandemic.

So that nations could borrow less, they were able to buy more euro-area government bonds.

“In 2020-21 the Bank of Italy purchased over 100 percent of the net supply of Italian central government bonds. We estimate that 60% of the net issuance will be bought by the central bank in 2022. Ducrozet stated that this demand source will disappear in 2023. This highlights the evolving landscape of monetary policy.

He concluded that Italy’s growth and future fiscal outlook would be crucial.

Fragmentation of the political system

Italy’s parliament is another problem. It often suffers from huge political fragmentation that can impact its growth and financial outlook.

It is clear that party leaders don’t have strong control over the parties, it seems. “That’s what makes us nervous,” Gilles Moec of AXA Investment Managers said Monday to CNBC.

The political fragmentation in the country is so bad that it took lawmakers eight times to vote for a new president. After nearly a week of inconclusive voting, lawmakers decided to ask Sergio Mattarella to continue as the country’s president — despite him wanting to leave the job.

Wolfango Piccoli (co-president, Teneo) stated in a last week note that while Mattarella and Draghi might provide some relief in the short term, Italy’s future prospects for the medium to long-term are highly uncertain.”

With the Italian Prime Minister Mario Draghi, Sergio Mattarella is the President of the Italian Republic.

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Mario DraghiThe country has seen stability since the time he served as prime minister. He devised a strategy to help the country invest nearly 200 billion euros (228.6 trillion) in European pandemic relief funds, while still retaining the support and backing of major political parties.

However, Draghi’s mandate comes to an end in the spring of 2023 — when new parliamentary elections are due.

It is now unclear whether Draghi (a former president of the ECB) will be able to continue implementing important reforms after his term ends. The groundwork for political parties and, in a more general sense, uncertainty about the type of coalition that will emerge from the election, will be laid soon.

Piccoli explained that Draghi needs to be a strong leader to manage the politics of Italy. However, Piccoli noted that Draghi alone isn’t enough to sustain the country over the long term.

It is ‘not one country that the EU cannot do without’

In the aftermath of next year’s election, opinion polls predict a split Parliament in Rome. Current polls show that the center-left Partito Democratico party and far-right Fratelli D’Italia share the same support, with around 21%. With 18%, the anti-immigration Lega Party is next. The Five Star Movement on the left stands fourth with 14%. According to Politico data, this is the final result.

The next election is expected to be close and different coalitions are possible. It will interest investors to find out if Rome will continue to implement the economic reforms necessary to qualify for the huge European recovery funds. This will help boost Italy’s economy.

Gilles Moec of AXA Investment Managers said that markets will “be very vigilant about that.”

It is not clear, however, if any of the parties are willing to carry out the reforms Draghi agreed upon with the EU.

“Well, I don’t see why (Italy’s economy should be at risk),” Francesco Lollobrigida, Parliamentary Leader for Brothers of Italy told CNBC in Rome, when asked if his party understood the economic risks of not reforming.

Italy cannot be a member of the EU without it. For a strong Europe, a strong Italy will be useful. Both must be done simultaneously,” he stated.

Italy’s large-scale recovery plan for Europe is heavily dependent upon it. It is the only EU country that receives more funds under this program than Rome. Europe’s ability to implement its objectives would be compromised if they fail to reform the system and don’t get these funds.

This article was contributed by Anita Riotta, CNBC.

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