Italy bond yields soar as debt crisis enters endgame

The difference between Italian and German 10 year bond yields has risen to its highest level since the Euro currency was introduced.

At 9am UK time Italian debt was offering a 6.568% yield, 4.77% greater than Germany's. Quite simply Italy cannot afford to borrow at that rate which leaves it just short of the 7% figure that spelled catastrophe for Greece, Portugal and Ireland. The trouble is, Italy's economy is three time bigger than those countries combined.

The perception in the markets its twofold. Firstly the numbers. The Italian government owes 120% of its total annual economic and needs to borrow around €300bn next year.

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Humiliatingly, the country has also "asked" (tranlastion: been ordered to bring in) the IMF to monitor its austerity programme. The austerity programe however is also a cause of massive instability which leads to the second issue investors are having to weigh up: Italian politics.

Silvio Berlusconi may be in charge but he is not in power. He faces a crucial vote of confidence in the Italian parliament on Tuesday (one to watch for currency traders) but the real question is what happens if he falls.

Opposition to Berlusconi is fragmented and it is an open question who would take over from him should he lose tomorrow. The Italian political system seems incapable of both managing its finances and responding quickly to circumstances.

There are clear currency positions that flow from this uncertainty. Many traders will consider taking positions on the Euro as the results from tomorrow vote come in. The wider context though is the future of the Euro. There is no plan B for an Italian default, the European Central Bank has threatened to stop buying Italian bonds if the country fails to implement cuts and the Eurozone bail out package available in case Italy does go bust is not considered big enough to fund the country through the crisis.

It is therefore becoming more and more difficult to disagree with the market perception that Italy is heading for the knackers yard, and the Euro along with it.

BS