To prevent its bond yields from rising, Italy needs a bailout now, not later. Specifically, it needs a dedicated firewall of at least €500 billion . This is because if bond yields were to rise too high too quickly, Italian public finances will deteriorate, and Italy will then be increasingly unable to roll over its debt.
The European Central Bank is the only authority with the wherewithal to finance this bailout. But they won’t at the moment.
The bond market has been pricing an implicit ECB guarantee concerning Italian sovereign debt. Thus, should the ECB fail to act this could become another global credit crisis trigger. So the ECB is basically being held hostage by the bond markets.
At present, the ECB only has the authority to purchase an additional €150 billion of Italian debt before it breaches the self-imposed 33% issuer limit. German and Dutch hawks on the ECB governing council have expressed opposition to even contemplating any breach of this ceiling. This impending bailout will test European political unity shortly.
The ECB must ride to the rescue over the objections of the fiscally upright German and Dutch council members, assuming all of the repugnant moral hazard that comes with that. The only alternative is an Italian default and subsequent “Italexit” that would send shockwaves reverberating throughout financial markets worldwide. And it would blow-up the Eurozone in a heart beat.
