Italian government bond yields jumped again this morning, as Prime Minister Mario Draghi resigned. Snap elections are expected to be announced shortly. Yields on Spanish, Portuguese and Greek government debt are also climbing.
Elections could benefit the hard right in Italy, which could throw the structural reforms, required for the release of the rest of Italy’s allocated recovery funds, out of the window. Eurozone bond spreads may get a short-term reprieve today from the ECB, as it sheds more light on its anti-fragmentation tools. But they are likely to widen thereafter.
The IEA was right to warn this week: “This winter could become a historic test of European solidarity – one it cannot afford to fail – with implications far beyond the energy sector. Europe may well be called upon to show the true strength of its union.” The Russian invasion of Ukraine and the related surge in energy prices threatens a wave of political upheavals in the EU, both within and between member states. The current crisis is a real threat to European unity.
The European Commission announced yesterday the “European Gas Demand Reduction Plan, to reduce gas use in Europe by 15% until next spring”. But already, disputes are arising as to who should shoulder the burden. Spain has already rejected the EU’s proposals. Meanwhile, criticism of the ECB is ramping up in Germany. German opposition to subsiding peripherals was loud enough when its economic model was working, relying on cheap Russian natural gas to become an export powerhouse.
But the erosion of the Eurozone trade surplus has been swift: it is not just an energy story. Costs for businesses in Europe have risen by much more than in Asia, notably China. As a result, European manufacturing has continued to lose competitiveness vis-à-vis China (which in turn is now the beneficiary of cheaper Russian energy). The euro has edged up against the dollar and remains above 1.00, but could fall well below parity, perhaps to 0.95 in the coming months.
