An OMT backstop would be a poor outcome for Italy

Speculation is rife in the government bond markets that the European Central Bank will deploy special monetary policy to support Italian BTPs. Aside from being a ridiculous idea — Italy has got itself into this mess with its own budget proposals, not because it is in a financial crisis — such support brings with it yet more rules that Italy would have to abide by in order to receive the help.

  • By Burhan Khadbai
  • 04 Dec 2018
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The ECB’s Outright Monetary Transactions (OMT) programme was launched in 2012, a week after the bank's president Mario Draghi pledged to do "whatever it takes" to save the euro at the height of eurozone sovereign debt crisis.

The as yet undeployed OMTs allow the ECB to buy sovereign bonds in the secondary market with a focus on maturities of between one and three years.

Of course, the argument for the use of OMTs is to bring down Italy’s government bond yields, which have rocketed to multi-year highs. With the ECB set to end its Public Sector Purchase Programme (PSPP) at the end of the year, BTPs are likely to take a further beating in 2019.

The big concern is if, or when, the BTP/Bund spread reaches the 400bp mark, which is likely to be the breaking point for contagion into other markets, according to market players.

In October, Draghi said the only way that the central bank could help Italy would be through through OMTs. But such a programme would not be plain sailing. 

In order for the ECB to give support through OMTs, Italy would need to join a bailout programme with the European Stability Mechanism. This could either be a full macroeconomic adjustment programme or a precautionary programme.

But in order for that to happen, the ESM would have to approve the bailout and set a number of conditions for Italy to run alongside it. The IMF would also be asked to help design and monitor the programme.

But Italy's problem is that its government wants less control from the EU, not more, hence the budget stand-off with the European Commission in the first place. All roads may lead to Rome, but the Italian government would prefer if they did not all come via Brussels.

But the Commission is right to take issue with Italy's draft budget and its plans for a growing deficit.

“Most of the advantages from the planned expansionary fiscal policy are likely to be eroded by Italy’s structurally high vulnerability to external shocks, the tightening in monetary conditions stemming from wider bond spreads and the impact of political uncertainty, encouraging precautionary savings and holding back consumption,” said BNP Paribas in a research note on Friday. “A fully fledged recession in Italy is a significant risk for 2019.”

The best, and most sensible outcome, is for Italy to lower its budget deficit target to one that is more appropriate for a country already burdened with an high debt-to-GDP ratio, and for it not to go picking fights with the EU, which Greece and the UK have found in recent times is not an institution that lets its members, committed or departing to dictate policy.

Over the last week, there has been some promising movement in that direction, with Italy’s top government officials suggesting they could target a budget deficit as low as 2% of GDP. That is a big reduction from the 2.4% target they had previously proposed.

BTPs have rallied in response. The yield on Italy’s 10 year was trading at 3.15% on Tuesday afternoon, the lowest level since the start of October. Meanwhile, the 10 year BTP/Bund spread was trading at 288bp, also the lowest since the beginning of October.

Italy doesn’t need special treatment form the ECB and it would be an undesirable route to take. Instead it needs a sensible approach to running a budget from its own government.

  • By Burhan Khadbai
  • 04 Dec 2018

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 161,597.45 701 8.06%
2 Citi 158,100.45 638 7.89%
3 Bank of America Merrill Lynch 131,322.73 520 6.55%
4 Barclays 126,396.71 489 6.30%
5 HSBC 104,257.54 522 5.20%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
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1 Bank of America Merrill Lynch 12,900.23 34 6.65%
2 BNP Paribas 12,334.48 61 6.36%
3 UniCredit 11,196.47 58 5.77%
4 Citi 9,580.75 37 4.94%
5 Deutsche Bank 8,953.95 35 4.62%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
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  • Today
1 Morgan Stanley 5,454.13 25 10.64%
2 JPMorgan 4,766.13 27 9.30%
3 Goldman Sachs 4,280.20 20 8.35%
4 Citi 3,649.88 23 7.12%
5 UBS 3,602.23 16 7.03%