ECB says Italy’s budget risks damage in the long run

European Central Bank officials warned that uncertainty and tension over Italy's expansive budget risk causing damage to the country's economy in the long-run.

"Italy's current financing conditions are much too tight for a country with weak growth and low inflation," ECB chief economist Peter Praet told Handelsblatt in an interview published Thursday.

Italian central bank Governor Ignazio Visco urged his government to lower debt financing costs by reducing uncertainty.

While the country's bonds have risen in the past two days, 10-year yields are still near 3.5 per cent, far higher than at the start of the year. In addition to investor pressure, the European Commission has rejected the budget of the populist government.

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Earlier this week, finance minister Giovanni Tria said that the needless drama is hurting the economy.

Speaking in Munich on Thursday, ECB Executive Board member Yves Mersch said it was “imperative” for highly-indebted euro area members to balance their books and reduce debt.

He also warned – without specifically naming Italy – that the lack of fiscal discipline in one euro-zone country could spill over to the rest of the region.

Praet said that he doesn’t see any real contagion effects so far. He signalled that the ECB won’t intervene so long as the problem affects only Italy, as it conducts monetary policy for the euro area as a whole.

If contagion did occur, “we would have to analyze the situation”, he said. Outright Monetary Transactions – a tool devised by the ECB at the height of the debt crisis and which has never been used – would be the “appropriate instrument.”

But the country would need to apply for assistance from the European Stability Mechanism.

Asked about other ECB policy tools, such as recent speculation around a new round of cheap funding for banks, Praet responded that it’s “premature” to decide now.

In December, the ECB will discuss guidelines for reinvesting maturing debt under its asset-purchase program.

Italian deputy premier Luigi Di Maio said: “We will not cut the key points of the budget plan,” in an interview published Friday in newspaper La Repubblica.

He said he favours sitting down with the European Commission to discuss the government’s spending program.

The ECB published an account of its latest policy meeting on Thursday, showing that officials acknowledged “uncertainties and fragilities,” while agreeing they weren’t enough to weaken the economy’s overall momentum.

Euro-area consumer sentiment dropped more than expected in November, possibly denting hopes that the region will rebound after a summer slowdown. The next test of ECB confidence comes on Friday, when flash PMI surveys for November will be released. – Bloomberg