Spiking Bond Yields Put Pressure on Italy

Rising government bond yields are threatening Italy’s ability to borrow money, analysts said Tuesday.

Italian 10-year government bonds rose beyond 6.5% for the first time since the introduction of the euro, and Italy is nearing levels that other European countries hit shortly before receiving bailouts.

With its debt at €1.9 trillion ($2.62 trillion) and an additional €200 billion due next year, Italy can ill afford to borrow money at high costs. Italian 10-year government bond yields rose to 6.66% Tuesday morning, while the country’s government debt has grown to 120% of its GDP. Greece, Ireland and Portugal sought assistance in lessening its debts after their bond yields passed 7%, causing concerns that Italy also will succumb to high borrowing costs.

Analysts at Barclays Capital wrote in a research note that current Italian bond yields are “clearly unsustainable,” adding that negative market dynamics have left few options for Italy.

“There comes a point where the cost of borrowing makes it impractical to borrow,” said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott. “Selling bonds at around 7% costs more and can make the debt worse.”

Italy’s internal options are limited as a result of high borrowing costs, although the country can tackle its debt and help improve investor sentiment by implementing significant austerity measures.

“Italy can enter into a larger austerity package, on that is larger by wide margins. They can show the market that they are serious about decreasing the debt,” LeBas said.

Barclays analysts Michael Gavin, Piero Ghezzi and Antonio Garcia Pascual wrote that reform is necessary but cannot sufficiently improve the Italian credit and reverse a “confidence crisis” that could overshadow any austerity measures.

So far, external help in the form of bond purchases have not kept Italian bond yields from rising.

A bond-buying campaign by the European Central Bank did not prevent the 10-year note from rising. The ECB bought over €9.5 billion ($13.1 billion) of Italian bonds in an effort to keep yields low, but the benchmark 10-year bond continued to rise.

“If the ECB were to buy Italian debt to bring yields within 100 basis points of Germany, I expect the market to snap back quickly,” LeBas said. “Banks have slowed their buying of European debt. In that scenario, the ECB would basically provide liquidity, and bank buying would return since they can then sell debt to the ECB.”

Banks have long been a principle buyer in European sovereign debt, although they could turn away from buying sovereign bonds. Investors already have started to sell Italian bonds, sending yields higher, and banks are becoming increasingly concerned with holding too much credit risk in European countries.

“The ECB is hesitant to step up to the plate,” LeBas added. “They haven’t thrown their infinite resources at the problem. There seems to be this excessive hopefulness that it will solve itself.”

Italian Prime Minister Silvio Berlusconi's government won an important budget vote Tuesday, although he failed to retain a majority of support in parliament. The opposition is expecting to bring forward a no-confidence motion, while there is mounting pressure for Berlusconi to resign.