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Euro at Risk: How the EU Might Punish Italy

Euro at Risk: How the EU Might Punish Italy

2018-11-21 02:00:00
Dimitri Zabelin, Junior Currency Analyst
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TALKING POINTS – Euro, Italy, eu, budget

  • Rome and Brussels collision over budget is intensifying
  • Yield spread between German and Italian bonds widening
  • Unprecedented stalemate likely to cause flight from Euro

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The war of words between Rome and Brussels is intensifying with EU policymakers heading into unchartered waters. After two budget submissions were rejected, the EU Commission has decided to meet on Wednesday Nov. 21st to discuss the possibility of opening up a case for the Excessive Deficit Procedure (EDP).

The punishments include a fine of 0.2 percent of GDP. Normally, this process would only begin in April of 2019. However, the Commission may be able to expedite the process and begin imposing fines as early as this month. The punishment would take the form of a non-interest bearing deposit. This sanction could only be avoided if more than half of all Eurozone finance ministers reject it within 10 days of adoption.

If the deposit is made, the Italian government is given 3-6 months to implement the necessary reforms. If the proper changes are not made, the deposit turns into a fine. If the government refuses to pay the initial deposit and subsequent fines, the issue would likely be taken up to the European Court of Justice.

Another punitive measure may also entail freezing Italy’s access to funds such as the European Stability Mechanism and the European Structural and Investment Fund. They may also be denied access to the Outright Monetary Transaction, a process whereby the ECB buys the bonds issued by member states from secondary sovereign bond markets (although this has not been used in practice so far).

Uncertainty about how policymakers will navigate these uncharted waters is likely to widen the spread between German and Italian bond yields further, implying increased reluctance to lend to Rome versus Berlin. It may also encourage capital to flow out of the Euro until clearer bearings may be established, sending the single currency broadly lower.

EUR/USD Decline, German and Italian Yield Spread Widening

Euro vs US Dollar, Italian vs German Bond Yields

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--- Written by Dimitri Zabelin, Jr Currency Analyst for DailyFX.com

To contact Dimitri, use the comments section below or @ZabelinDimitri on Twitter

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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