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Victory for Italian PM and bonds

European investors breathed a sigh of relief last week as Italian prime minister Enrico Letta survived a vote of confidence, which threatened to bring down his government and disrupt vital budget negotiations.

Italy’s 10-year bond yields – an indication of its cost of borrowing money – have been volatile throughout 2013, approaching 5 per cent on several occasions. This has largely been driven by ongoing political uncertainty about the outcome of February’s elections.

Mr Letta, of the ruling Democratic Party, was left facing a vote of confidence after former prime minister Silvio Berlusconi withdrew the support of his People of Liberty party from the government. But after several senators from Mr Berlusconi’s party indicated they would support Mr Letta’s government, Mr Berlusconi was forced to backtrack on his plans. Mr Letta won the confidence vote on October 2 by 235 votes to 70.

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Italian bond yields fell following Mr Letta’s victory and its stock market rallied on Wednesday. But fund managers last week warned the victory would not ease fears of the eurozone’s sovereign debt crisis resurfacing, particularly as Italy remains mired in its longest post-war recession having endured seven consecutive quarters of its economy shrinking. It also has the eurozone’s highest level of debt relative to its economic output.

Stewart Cowley, head of fixed income and macro at Old Mutual Global Investors, has been running a short position in Italian bonds “for some time”, meaning his £927m Old Mutual Global Strategic Bond fund stands to benefit if the price of Italian government bonds falls.

Mr Cowley said: “Italy has raised non-payment of taxes to the level of a national sport.

“The Italian government now borrows the unpaid tax off its own citizens, for which it pays them a rate of interest. This has taken Italy to the point that it now has a very unstable situation mathematically – Italy borrows money to pay its interest bill.

“You don’t have to be a client of Wonga.com to realise that once you have to borrow money to pay interest, you are in trouble. Add the politics on top and, even if they get through this short-term crisis, fundamentally something has to give.”

Royal London Asset Management’s head of fixed interest Jonathan Platt said last month’s German elections, in spite of maintaining German chancellor Angela Merkel’s position in charge of the eurozone’s largest economy, had “not resolved anything”.

He added: “In Italy it is business as usual as political turmoil returns after a summer break. These developments mask the real issue of how the eurozone can foster economic growth that is enough for all members within a single currency framework – a near-impossible task without much greater political union.”

Meanwhile Portuguese government bond yields rose as investors feared the country’s government was more likely to approach eurozone leaders for a second bailout.

It initially agreed a €78bn (£65.3bn) bailout with the International Monetary Fund and the EU in May 2011 in return for swingeing cuts and austerity measures. But late last month the ruling Social Democrat party lost heavily in local elections, which may affect its efforts to avert a second bailout.