[Kaiserschmarrn]

EU prepares to step up confrontation with Italy over budget

BRUSSELS (Reuters) - Italy’s budget dispute with Brussels is likely to escalate in coming weeks unless Rome revises its free-spending plans, EU officials say, and could lead to fines, a freeze of EU funds and bond-sale monitoring.

Last week, the European Commission rejected Italy’s draft budget for next year, saying it was in blatant breach of European Union fiscal rules and could further increase the country’s huge pile of public debt. Despite the EU warnings and market turmoil that increased Rome’s debt servicing costs, Italy’s eurosceptic government has not backed down from its plan to increase its budget deficit to 2.4 percent of gross domestic product (GDP) next year. Italy’s stance is likely to draw criticism from euro zone finance ministers at their monthly meeting on Monday, officials said, stressing the country was isolated in the 19-state euro currency area.

Rome says its planned deficit spending for welfare handouts, earlier retirement and investments will boost growth and therefore reduce debt. It has so far shown no willingness to change the draft by a Nov. 13 deadline set by Brussels. EU officials say that if there is no change, the Commission is likely to react at its Nov. 21 meeting by launching a disciplinary procedure on the grounds that Italy’s excessive debt of more than 130 percent of GDP is not decreasing as required. The move has been long foreseen but not expected as early as this month. The Commission has in the past always waited for final data on public finances, available in April, before taking any disciplinary action on euro zone states. But this time it could instead act on its own economic forecasts, due on Nov. 8, which are expected to show a far less optimistic scenario than the 1.5 percent GDP growth in 2019 predicted by the Italian government. Estimates of lower growth would translate into a higher debt and deficit.

As a precautionary measure, Brussels could ask Italy to transfer a non-interest bearing deposit of 0.2 percent of its GDP to the bloc’s rescue fund, the European Stability Mechanism. The Commission could also set a deadline, that could be as early as February, for Italy to take action to reduce its debt. Missing that deadline could trigger harsher sanctions, including an actual fine of up to 0.2 percent of GDP, the suspension of billions of euros in EU funds and closer fiscal monitoring by the European Commission and the European Central Bank, involving missions in Italy similar to those in bailed-out countries like Greece.

If it continued to fail to cooperate, Rome could face even stricter penalties under EU rules. They might include a fine of up to 0.7 percent of GDP, a cut of multi-billion-euro loans from the European Investment Bank, of which Italy was the EU’s largest beneficiary last year, and EU precautionary monitoring over Italy’s plans to issue new debt.

Italy's latest economic figures don't look too good, but this hasn't led the Italian government to backtrack - at least not yet.

Biggest Italian Factory Slump Since 2014 Hits Euro Economy

Italian manufacturing contracts as Germany and France slow
ECB must decide next month whether to cap its bond holdings

Italian manufacturing shrank the most in almost four years in October, hinting at continued weakness after the economy failed to grow in the third quarter. IHS Markit’s factory index for the country dropped below the key 50 mark, meaning a contraction -- the first since August 2016. Output shrank for a third month and new orders fell as optimism took a knock from slower global demand and “worries over political stability.” The euro-area manufacturing PMI slid to 52.0, below the initial estimate of 52.1 and the weakest reading in more than two years.



The figures are another blow to Italy after last quarter’s stagnation, led by industry. Amritpal Virdee, an economist at IHS Markit said the sector may drag down wider economic growth again this quarter. Italy’s populist government says the slump makes their expansionary fiscal plan even more necessary, even as critics fret about the country’s huge debt pile. The administration intends to stick to its controversial budget plans despite criticism from the European Union and the country’s central bank.



The PMIs continue a run of disappointing figures in the euro area, and add to concerns that the global economy is cooling. Average growth in the currency bloc was slower than expected in the third quarter, and measures of confidence since then have slipped lower. In Germany, where the economy probably stalled in the third quarter, the manufacturing PMI for October also fell to the lowest in more than two years. Similar slumps were seen in the Netherlands, France and Austria.

The readings increase pressure on the European Central Bank to explain whether it still intends to cap its bond-buying program at the end of the year. Officials will meet on Dec. 13 to set policy and review fresh economic forecasts. “Growing risk aversion, linked in turn to worries about the global economic environment, trade-war worries, political uncertainty and rising prices appears to be hitting demand for a wide variety of goods,” said Chris Williamson, chief business economist at IHS Markit.

[Baff]

The more debt it takes on, the less likely it will leave Euro.
Because deflation will cause interest rates to spike and make repayments cost more.

Not sure how that effects shadow currency option.