Analysis: Euro debt crisis - Italy no longer quite so safe - Reuters

By Gavin Jones

ROME | Wed Dec 1, 2010 1:54am EST

ROME (Reuters) - Italy has so far largely avoided the debt crisis that has engulfed Greece and Ireland despite having the region's weakest growth record, a huge public debt and notoriously unstable politics.

That suddenly seems in danger of changing.

Italian officials tried to reassure markets on Tuesday as concern rose that the euro zone's third largest economy is becoming embroiled in the region's spreading debt crisis, with possibly unmanageable consequences.

Unimpressed, investors pushed the interest rate spread between Italian bonds and benchmark German Bunds to a euro-lifetime high as they focused more on Italy's weaknesses than its strengths.

"Now it is looking like a liquidity crisis on the government bond market, which is critical for Italy with its huge refinancing needs," said Citibank analyst Giada Giani.

"The markets are already taking for granted that Portugal will need a rescue package and they are targeting Spain and Italy. Now only the ECB can help, by buying government bonds."

Unicredit analyst Marco Valli said the situation was worrying but had not yet spiraled out of control. He also urged "massive" intervention from the ECB.

"We mustn't get carried away, the yield on Italian 10-year bonds is still below 4.7 percent which is no problem in terms of refinancing costs," he said.

Italy has one of the highest absolute debt levels in the euro zone and meeting its refinancing needs for the next three years would cost in excess of 800 billion euros.

EU rescue funds, augmented with IMF backing, can muster a total of 750 billion euros for nations needing aid. The thick end of 100 billion has just been given to Ireland.

"It's very worrying because Spain is almost too big to be bailed out ... whereas Italy is too big to be bailed out," said Everett Brown, European bond strategist at IDEAglobal.

For months, economists and officials have insisted that Italy, with relatively sound fundamentals should be immune from market attack, yet markets don't seem to be listening.

STRENGTHS

Unlike former high-growth success stories such as Ireland and Spain, Italy, for all its problems, does not look all that different to how it did before the recession of 2008 and 2009.

Thanks to a prudent fiscal policy its public finances have deteriorated much less than in most euro zone countries, it suffered no housing crash, and none of its banks needed to be bailed out with public money.

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