Europe, Italian-Style

MILAN – Last summer, after two years of growing uncertainty, systemic risk in the eurozone finally began to wane, as conditional commitments came together. Italy and Spain offered credible fiscal and growth-oriented reforms, and the European Central Bank, with Germany’s backing, promised intervention as needed to stabilize the banking sector and sovereign-debt markets.

Unfortunately, that trend may be reversing. Growth in the eurozone has turned negative overall, significantly so in the south. Unemployment stands at about 12% in Italy, and 38% for the young. Likewise, Spain’s unemployment rate is above 25% (and 55% for young people). And French economic indicators are slipping quickly.

Meanwhile, the outcome of Italy’s election will most likely leave the country – the eurozone’s third-largest economy and the world’s third-largest sovereign-debt market – without a stable government. As a result, it will be difficult to sustain a reform program that is vigorous enough to satisfy the ECB and the eurozone core.

Surprisingly (to me, at least), markets have reacted stoically. Interest-rate spreads on Italian sovereign debt have widened, but not sharply. External investors may not be rushing for the exits, but they are not piling in, either. It feels like wait and see at this point.