Italy's key borrowing rate spiked Wednesday well above the seven per cent level that eventually forced other eurozone countries to seek bailouts, amid uncertainty over who would lead the country when Prime Minister Silvio Berlusconi steps down.
On Tuesday, Berlusconi said he would step aside for the good of the country once Parliament passes economic reforms and wouldn't run again for office.
His move saw a brief rally in markets but sentiment quickly reversed as it remained unclear what government would take over.
The yield on Italy's 10-year bonds surged Wednesday to a high of 7.4 percent, up 0.82 of a percentage point from the previous day.
The seven per cent level is considered unsustainable for a government over the longer-term. Greece, Ireland and Portugal had to ask for rescue loans once it became clear that their borrowing rates were stuck above that threshold.
Unlucky number seven
The fact that Italy’s bond yield has topped seven per cent is notable because the figure has become something of a benchmark — it was after hitting that plateau that Greece, Portugal and Ireland each sought bailouts.
By itself the figure doesn’t necessarily spell disaster, but in mid-2010 Italy’s bond rate was around four per cent. The IMF has pegged Italy’s five-year average economic growth rate at just 3.3 per cent, and if bond rates remain higher than this for any amount of time, it seriously hinders the country’s ability to pay down its debt.
Another ominous sign is the widening gap between Italian and German 10-year bond yields, which on Monday reached a euro-zone era record of 4.75 percentage points.
The key is how long the rate stays at that level.
"It takes time to permeate to the rest of the debt mountain," said Jan Randolph, head of sovereign risk analysis at IHS Global Insight. "Seven per cent is not sustainable over several years. It has to be brought down eventually. Otherwise, we are in danger."
He noted that Italy is in better fiscal shape than either Greece or Portugal when they sought bailouts — its deficit is below the eurozone average, but growth is weak.
But with debts of around €1.9 trillion ($2.7 trillion Cdn), Italy is considered too big for Europe to bail out.
Berlusconi wants new elections soon with his hand-picked successor, Angelino Alfano, as a candidate.
"I won't run, actually I feel liberated," Berlusconi was quoted as telling La Stampa. "It's Alfano's turn."
Berlusconi tapped Alfano, his former justice minister, to head his People of Liberties Party a few months ago. At 41, Alfano represents a new generation of center-right politicians after 17 years of Berlusconi leadership.
Mario Monti, a former EU competition commissioner who now heads Milan's prestigious Bocconi University, has been widely tipped as a candidate to head a technical government.
Berlusconi conceded it was up to President Giorgio Napolitano to decide how to proceed once he steps down.
Elections not the only path
It's not clear that Napolitano would want to subject Italy to elections given the need to calm markets.
He may try to sound out politicians about the possibility of forming either a government of technocrats or a broad-based government that could hold a majority in Parliament to finish the legislative period, which runs into 2013.
"The best-case scenario is Mario Monti, and everyone rallies around him," said Randolph, the sovereign debt analyst.
Berlusconi's announced departure from office was greeted with relief among ordinary Italians but also wariness about what lies ahead.
"I'm more interested in what's going to happen afterwards," said Caterina Tassa as she bought newspapers at a kiosk near Rome's ancient Pantheon Wednesday morning.
"The political class in general is very bad. So let's just say I'm not very calm."
Napolitano tried to reassure roiling markets that Berlusconi will resign and said Italy will either have a new government or early elections soon.
Napolitano says concerns about whether Berlusconi would actually leave office are completely unfounded.
He said economic reforms demanded by the European Union would be passed by parliament "in a matter of days" and that he would work to avoid a prolonged period of political uncertainty.