Europe Macro – February 2, 2022

| February 2nd, 2022

Today is all about inflation. In the euro area, inflation came in way above expectations in January. Not only did energy contribute, but we witnessed a steep increase in food inflation as well. This is set to last as consumer-focused companies are currently hiking their prices while commodity prices keep rising. Meanwhile, the chip supply crisis is almost certainly going to make it into 2023 according to insiders, which will weigh on the automotive industry. Additionally, we take a closer look at the tricky economic situation in Italy (which will be a big topic going forward) and the fact that the EU cannot offset Russian gas imports using Qatar or Australia. 


1.1 Will interest rates rise? The Times shadow MPC thinks they should – The Times

The Bank of England should raise rates by at least 0.25 per cent tomorrow to show that it is serious about tackling inflation, according to The Times’s shadow monetary policy committee.

The committee was divided on whether to raise rates by 0.25 percentage points or by even more. Five of the nine members of the shadow committee voted to increase the interest rate to 0.5 per cent from 0.25 per cent, while two opted for a 0.5-point rise to 0.75 per cent. The other two backed a rise of 0.75 percentage points to 1 per cent.

Interest rates have not been as high as 1 per cent since 2009. They were cut from 5 per cent to 0.5 per cent in a year to aid the economic recovery from the 2008 financial crisis.

The Bank of England’s monetary policy committee will decide whether to implement back-to-back interest rate rises for the first time since 2004 at its meeting tomorrow.

At 5.4 per cent, the annual rate of inflation, now at its highest since 1992, is almost triple the central bank’s target of 2 per cent. Unemployment levels are close to historic lows at 4.1 per cent with the number of vacancies almost equal to the number of people jobless for the first time since comparable data was recorded more than 20 years ago.

[…] Martin Weale, a former ratesetter at the Bank and professor at King’s College London, voted in favour of a 0.75-point increase to the base rate to offset the risk that expectations of high inflation are built into decisions about wages and price levels.

Inflation will be elevated in the coming months but the simultaneous rise in national insurance contributions, minimum wages and energy prices in April will hit demand, according to Karen Ward, chief European market strategist at JP Morgan Asset Management, who voted for a 0.25-point rise.

Comment (The Times): The Bank of England’s monetary policy committee is struggling. It will announce its latest decision on interest rates on Thursday, having resisted raising them in the second half of last year.

In May 2021 Britain’s consumer prices index inflation rate rose above the official 2 per cent target. The initial reaction from the MPC was to tell us that everything would be fine. Inflation would soon subside after peaking at about 4 per cent. This was a temporary spike that would go away and no policy action was required.

By November, we received an official acknowledgement from the Bank of England forecasts that inflation would peak at 5 per cent. In December, when the MPC reluctantly took the move to raise the official Bank Rate from 0.1 per cent to 0.25 per cent, it acknowledged that the CPI inflation peak would be 6 per cent.

Now most independent economists expect CPI inflation to reach a peak of 6 per cent to 7 per cent and the Bank is still at the low end of these expectations. The most recent forecasts reported to the Treasury also expect inflation to be about 4 per cent by the end of this year. In other words, the current inflation surge will not be short-lived.

The Bank has about 50 economists working in its monetary analysis divisions. It is still getting its forecasts badly wrong and that has serious consequences for the management of economic policy.

[…] Since 2009, the MPC has had a more chequered record and there are many questions that need to be answered. First, why were many promises to raise interest rates since 2013 not followed through under Mark Carney’s governorship? He made many statements about future monetary policy that were either reversed or ignored.

Second, it appears that the diversity of debate on the MPC — which was a characteristic of my time on the committee — has faded away. Again, since the Carney era, there has been an emphasis on consensus views on monetary policy, which I believe runs counter to the tradition of the MPC.

Third, there has been no clear strategy for normalising UK monetary policy since the global financial crisis. The lack of a clear strategic approach since 2010-11 has been very noticeable. All the focus in the past decade has been on how short-term indicators affect monetary policy decisions, with little focus on a long-term strategy.

[…] So what happens next? First of all, if the MPC ducks a decision to raise interest rates this month and later this year, its credibility will be seriously undermined as a regulator of UK inflation. Second, we need a serious review of the conduct and performance of the MPC at its 25th anniversary. Hopefully, the Treasury select committee will be able to conduct this inquiry, as it did after ten years of the MPC in 2007. But I think this time around the verdict will be more critical.


2.1 Inflation in the euro area rises to record high – investors bet on interest rate hike – Handelsblatt

The inflation rate in the euro area increased again at the beginning of the year. Prices rose by 5.1 per cent, according to a first estimate by the European statistics office Eurostat. Economists had initially expected a decline – to 4.4 per cent. However, data from individual EU countries such as Germany published at the beginning of the week had already pointed to a higher value. In December, the price increase had been 5.0 per cent.

Experts expected a decline because certain special effects expired at the beginning of the year. On the other hand, certain prices, such as for gas, are usually adjusted at the beginning of the year. Energy prices in particular have risen further recently. This is the strongest deviation of inflation from the values forecast in advance, writes Frederik Ducrozet, analyst at the Swiss asset manager Pictet, on Twitter.

This is fuelling the debate about the central bank’s course ahead of the European Central Bank’s (ECB) council meeting next Thursday. The ECB decided in December that it would largely stick to its very loose monetary policy this year and only slowly reduce its massive bond purchases. In the meantime, investors are betting against it and are already pricing in two interest rate hikes this year. But only one side can be right.

Investors’ expectations are driven by two main factors. First, the US Federal Reserve has recently signalled a much faster tightening of monetary policy. At last week’s meeting, it not only held out the prospect of several interest rate hikes this year, but also a reduction of the balance sheet. Moreover, in view of the inflation figures at the beginning of the year, there are already indications that the rate for the year as a whole could also be higher than expected.

[…] At the beginning of the week, Deutsche Bank, for example, raised its inflation forecast for Germany for this year from 2.9 to 4.2 per cent. The chief economist of the Bundesbank, Jens Ulbrich, also wrote on Twitter that the January figures for Germany would indicate an inflation trend noticeably above its own December forecast. At the time, the Bundesbank had predicted an inflation rate of 3.6 per cent for Germany according to the European method of calculating the HICP.

Deutsche Bank now expects the ECB to raise the key deposit rate by 0.25 percentage points as early as December. Currently, this rate is minus 0.5 percent. This means that banks holding excess liquidity at the ECB will have to pay minus interest.

Comment: First of all, surprise! Inflation is (once again) higher than expected. One of the charts we used in recent articles is the one below. The Citi inflation surprise index is high in both the euro area and the US, yet the index exploded in the euro area.

In this case, consumer prices (preliminary) rose by 5.1%. It’s up from 5.0% in December and way above expectations of 4.4%. Int his regard, it is interesting that major banks like Deutsche are raising full-year inflation forecasts. In this case, the bank sees German inflation at 4.2%. Up from 2.9%. Talk about inflation being far from transitory.

One of the, if not the biggest driver of inflation, is energy. Going into 2022 a lot of customers are getting significant price hikes. On top of that, both natural gas and oil continue to trade close to multi-year highs. The result is 28.6% energy inflation, which is a new high as the graph below shows.

The table below shows that even if inflation is adjusted for energy, food, alcohol, and tobacco, the euro area ends up with 2.3% inflation. In this case, food prices rose by 3.6% – that’s almost twice the ECB’s target rate of 2%. Unprocessed food inflation reached 5.2%(!). Even services remained at 2.4%, which is anything but transitory.                                                     

Tomorrow, the ECB needs to provide answers. It needs to explain exactly what it will do to combat inflation as we’re in a situation where people are getting hurt. Energy poverty is slowly becoming mainstream in Europe and food inflation is next on the agenda to hurt everyone with a tight budget (we cover this in the article below).

And, even more important, the ECB might be trapped. If the ECB is eventually forced to hike, it could cut off countries like Italy and Greece from much-needed financial support. 

2.2 Double-digit price increases: Which products are now scarce and expensive – Handelsblatt

The gaps on the shelves are getting bigger. 49 percent of those surveyed could not find their desired product in the retail trade in December and January, shows a survey by the management consultancy Oliver Wyman, which is available to Handelsblatt. Even the consultants had not expected such a scale of problems.

“We had already expected clearly noticeable shelf gaps, but the fact that almost every second person did not get their desired product surprised even us,” says Rainer Münch, retail expert at Oliver Wyman. There were very clear gaps in availability in the trade. “Many customers were willing to spend money, but simply didn’t get what they wanted.”

But which products are actually in short supply, and what impact does that have on prices? A look at previously unpublished data from market researcher GfK reveals the details.

Electrical goods are the hardest hit. “Even if shelf gaps are not directly visible everywhere, the average number of products per retailer has decreased,” reports Tatjana Wismeth, supply chain expert at GfK.

However, the subsequent price increases varied greatly. Overall, prices in the electrical segment rose by four per cent in Germany last year (January to November 2021), according to GfK calculations, but in individual categories by a significant double-digit rate. Photo devices were at the top of the list, with prices rising by 20.1 per cent.

Comment: One thing we have consistently covered is stressed supply chains – we cover this in today’s issue as well in the “supply chains” segment below. While supply chain problems will ease this year, we can in no way assume that they will be solved. Yesterday, we discussed automotive supply chain problems that will last well into 2023. Today, we cover the impact on consumers. In this case, gaps in German shelves are getting bigger. In both December and January, roughly half of the people surveyed had trouble getting the products they desired. 

This includes electronics, that were more expensive as a result. Yes, while more expensive electronics are far from great, it’s not the pressing issue hurting the middle- and lower-class. Going into this year, we discussed the possibility of rapid food inflation as producers start to hike prices.

That’s now happening, and the result is downright ugly. According to Handelsblatt:

“If products are currently missing in the supermarket, it is usually due to escalated price negotiations between retailers and their suppliers. However, retailers are usually still successfully concealing the gaps in the assortment with alternative products. “In the food trade, we don’t feel empty shelves as much as inflation,” explains GfK expert Wismeth.

And that was something to behold last year. According to GfK, every seventh product group in the supermarket was more than ten percent more expensive. Nine out of ten product groups were above the prices of the previous year in the second half of the year.

“The price increases are very visible for basic items such as eggs, margarine or potatoes, also for toilet paper or kitchen rolls,” says Wismeth. Products such as chocolates or canned vegetables also became more than ten per cent more expensive. This is additionally due to the higher cost of tinplate.

The overall increase in prices for everyday goods, called “Fast Moving Consumer Goods (FMCG)” by experts, was 4.4 per cent last year up to and including November – clearly above the inflation rate of 3.1 per cent reported by the Federal Statistical Office.

The GfK data also show: consumers are reacting to the price shock by buying less and paying more attention to special offers. Last year, sales in FMCG retail stagnated. In the first pandemic year 2020, it still rose by twelve percent.”

The graph above shows consumer price growth in December – not preliminary data for January. Even before companies started to hike prices in 2022, multiple food items already saw strong double-digit price hikes. December of 2021 also showed that the only products that were down are “nice to have” products. “Must have” products went up between 70.5% and 13.7%, and there’s more to come in the months ahead. 

2.3 Strongest start to the year for house prices since 2005, says Nationwide – The Times

House prices have made the strongest start to the year in 17 years.

Annual growth was at 11.2 per cent in January, and prices rose by a better-than-expected 0.8 per cent over the month, figures from Nationwide showed.

Robert Gardner, Nationwide’s chief economist, said: “Housing demand has remained robust. Mortgage approvals for house purchase have continued to run slightly above pre-pandemic levels.”

The average price of a home is now £255,556, according to the mortgage lender’s measure.

The housing market has been growing strongly since the end of the first coronavirus lockdown in 2020, driven by the desire for bigger properties as people worked from home and helped by the chancellor’s stamp duty holiday tax break.

[…] Nationwide said houses had also become less affordable, with house price growth outstripping earnings growth by a wide margin since the start of the pandemic. It said that a 10 per cent deposit on a typical first-time buyer home is now equivalent to 56 per cent of total gross annual earnings, a record high.

Martin Beck, chief economic adviser to the EY Item Club, said that while house price growth would probably cool this year, he does not expect any serious correction.

“The unplanned savings built up by some households during the pandemic will go some way to offsetting the income squeeze,” he said. “And the growth in popularity of fixed-rate mortgages over the last decade means the majority of existing mortgage holders are protected from increases in mortgage rates in the short term. Meanwhile, the more stringent affordability criteria and mortgage regulation introduced during the 2010s mean recent buyers should be better placed to cope with higher mortgage rates than in the past.”

Comment (The Times): […] A shortage of homes for sale in the past year has pushed up prices nationally by 10 per cent and in some pockets of the country by as much as 20 per cent. This lack of homes is forcing buyers to look farther afield and consider different properties, with one in five (20.6 per cent) who viewed a resale home in the past year also viewing a new-build one, according to Hamptons. This is far higher than usual, the average is usually about 8-9 per cent.

Buyers who are in a chain and have found a purchaser for their own home, but are struggling to find somewhere to buy are most likely to view (and buy) a new-build home. Traditionally new-build has attracted more first-time buyers (many using the government’s Help to Buy scheme), but last year a record 45 per cent of new-build buyers had property to sell, up from 28 per cent in 2019.

However, despite developers marketing 40 per cent more homes in November 2021 than they had the previous year, the imbalance between supply and demand remains and builders aren’t going to come to the market’s rescue anytime soon.

A recent Home Builders Federation survey revealed that shortages of materials and labour combined with planning delays were thwarting development. The pandemic has sparked a global supply chain crisis and the building industry, which was already struggling with an ageing workforce, has been doubly hit by Brexit and Covid, with many European workers returning home.

[…] New-build purchases accounted for 12.8 per cent of all transactions between January and November 2019 in England and Wales, but this fell to just 2.2 per cent in 2021 despite unprecedented buyer demand, according to data compiled by Unlatch, a new-build sales platform.

The supply situation isn’t about to get better anytime soon, according to the economist Andrew Wishart at the consultancy Capital Economics, who says that shortages of construction materials will “cap housing starts for the next year or so, at about 40,000 a quarter”.

There are other stumbling blocks too: the Help to Buy scheme ending in March 2023 and squeezed affordability — inflation has just risen to 5.4 per cent with further interest rate rises likely.

“When the current difficulties sourcing materials eventually ease, the end of the Help to Buy Equity Loan scheme and cooling transactions will prevent a resurgence in housebuilding. As a result new-build construction is likely to ease from a peak of 219,000 homes in 2019-20 to about 190,000 in 2023-24. Neither the build-to-rent sector nor conversions of office space to residential will be able to offset the slowdown,” Wishart predicts.


3.1 Can Qatari gas offset disruptions to Russian supply in Europe? – Reuters

[…] Europe’s natural gas supplies from Russia are mostly delivered through pipelines and since October last year have been well below seasonal levels.

Flows in 2021 through Russia’s three main pipelines to Europe totalled 37,409 gigawatt hours/day (GWh/d) Refinitiv Eikon data showed, down from 41,263 GWh/d in 2020 and 49,431 GWh/d in 2019.

European storage stocks are around 19 billion cubic metres (BCM) below their five-year seasonal average, according to Platts analytics, despite other sources of supply being close to maximised over recent months.

Platts Analytics expects that even if Russian flows continue, European stocks will be near record lows at the end of winter, leaving little scope to absorb a further supply shock.

European liquefied natural gas (LNG) imports hit a record high in January at 11.8 bcm, compared with a previous record in November 2019 of around 9 bcm. Nearly 45% of the LNG imports were from the United States.

[…] Qatar, a top LNG producer, has little spare supply as most of its output is locked into long-term contracts.

Qatar’s nameplate LNG export capacity is 106 bcm. Luke Cottell at S&P Global Platts expects that to rise to only 107 bcm, capping Qatari exports.

It could produce more by deferring second-quarter maintenance, but its Asian contracts still limit its ability to supply Europe.

Traders estimate Qatar’s output breaks down into 90%-95% long-term contracts and 5%-10% spot contracts.

Long-term, point-to-point contracts, such as those from Qatar to China or to Japan, could be amended to release supplies for Europe, but any Asian customers that agree would want compensation.

Industry sources and analysts expect Qatar to divert only 8%-10% of its LNG to Europe, and even this will take time as it takes longer to ship LNG from Qatar to Europe than to Asia.

[…] Steady flows of LNG to Europe have already pushed up utilisation of 30-day average regasification capacity – that converts super chilled LNG back to natural gas – to 75% from 51% in early January in Western and Southern Europe, Rystad Energy said.

This means Europe has limited regasification and storage capacity to absorb further flows of LNG.

Comment: In a situation where Russian exports are (briefly) halted, Qatar will not be able to jump in to save the day. So, what about Australia? Australia has become the largest LNG export country in 2020.

What matters, too, is that Australia has been publicly critical of the Russian government’s troop build-ups and it has pledged to support its European partners in the ongoing energy crisis.

So far, this seems promising. The country is an LNG leader and eager to help. The question is how much Australia can help Europe alleviate its supply shortages, even if their government wants to?

One major issue is the fact that 75% of Australia’s gas exports are tied to long-term contracts, of which the overwhelming majority are with Asian buyers. The gas Australia can sell on the spot market would not make a difference.

Add to this that sales on the spot market are only attractive due to high price differences. Right now, natural gas prices in Europe are 3-4 times as high as they were last summer.

And that’s still not everything, Australia is looking to go carbon-neutral, which will be detrimental to its oil & gas and coal jobs. Meanwhile, Chinese LNG demand will rapidly accelerate, and it is very unlikely that the country will accept a breach of long-term contracts in order for Australia to ramp up supplies to Europe.

While it is smart that Germany (and other European nations) is looking to boost LNG import infrastructure spending – like terminals – there is no way that Europe offsets a potential drop in Russian natural gas exports. That’s not an option. Europe can do two things. First of all to make sure that the situation in Ukraine does not escalate. Second, working on long-term LNG deals with countries that are able to boost exports (Qatar, US, etc.) and improving LNG infrastructure. And on top of that – as a wild card none of the carbon-conscious politicians will use anyway – invest in domestic natural gas production(!). 


4.1 Chip manufacturer STMicroelectronics: “We are in permanent emergency mode” – Handelsblatt

Sold out until next year: Europe’s largest chip company STMicroelectronics is struggling with an unprecedented flood of orders. “We are in permanent emergency mode,” CEO Jean-Marc Chery told the Handelsblatt. The manager has to literally allocate the scarce semiconductors to the 200,000 customers.

Because the factories are working at full capacity, customers have to accept delivery times of up to twelve months. According to Chery, ST could achieve between 30 and 40 percent more turnover if the necessary machines were available. The Italian-French company supplies Tesla, among others, with chips for the power supply of electric cars.

There is no quick improvement in sight. The long-suffering buyers, many of them from the car industry, will need a lot of patience for the foreseeable future. In order to process the orders more quickly, Chery wants to invest about 50 per cent more this year than in 2021. More than three billion euros are to flow into new buildings and factory expansions. “But these additional capacities have already been completely allocated,” explains the Frenchman.

Anyone who needs chips quickly hardly has a chance at the moment. Neither at ST nor at the competition. The entire semiconductor industry is not keeping up with orders. The industry itself has underestimated its growth, criticises the head of chip manufacturer ASML, Peter Wennink. “Chip demand is insatiable.”

Worldwide, the assembly lines in factories are at a standstill because the electronic components are missing. This affects practically every chip customer. Gunther Kegel, President of the industry association ZVEI, explains: “The demand for semiconductors is greater than the production volume available.”

[…] A downturn is not expected for the time being. The consulting firm McKinsey expects annual sales growth in the industry of six to eight percent by 2030. The business with automotive semiconductors will grow disproportionately strongly. This is a central field of the leading European chip groups STMicroelectronics, Infineon and NXP.

For the current year, ST boss Chery is therefore promising an increase in turnover of around 20 percent. The strong growth is based on the one hand on the fact that ST is selling significantly more chips. On the other hand, the company is using the shortage to raise prices. ST produces mostly in Italy and France as well as in Singapore.

However, the chip manufacturers are only partly in a position to eliminate the supply bottlenecks themselves. Just as their customers have to wait for semiconductors, they too are not getting enough equipment for their factories. “The chipmakers can’t deliver as much as we would like,” Chery said.

Comment (National World): […] The Covid pandemic has contributed significantly to the semiconductor supply problems around the world.

Factory shutdowns and social distancing measures led to delays in production at already busy factories.

Making matters worse, the pandemic has led to a huge shift towards home working, which has increased demand for technology such as laptops, tablets and webcams, as well as more pressure on internet services and cloud computing facilities. This demand for more high-tech equipment has led to higher demand for the semiconductors which allow it to function.

According to trade body the Semiconductor Industry Association, sales of chips actually fell 12% in 2019 but were already growing (up 6.5%) in 2020 before rocketing by 30% between August 2020 and August 2021.

The value of semiconductors has historically been quite volatile, meaning makers don’t want to over-invest in multi-billion-pound factories for fear demand will disappear and profits could collapse at any moment. That means the industry is now playing catch-up to meet sustained demand for chips in everything from smartphones to cars with advanced driver assistance technology and cloud-connect infotainment systems.

The car industry is among those feeling the shortage most acutely. At the start of the pandemic, manufacturers scaled back their production plans as demand for cars fell away. That, combined with the fact that the automotive sector is a relatively small part of the chip makers’ business, means they are now at the back of the queue when it comes to securing vital electronic components.

However, the issues run deeper than Covid-related problems and some observers say that the industry was unprepared for such a sharp rise. Former Intel board member Professor David Yoffie, from Harvard Business School, says that the industry hadn’t appreciated how sustained demand would be and was only now responding.

Other more wide-reaching issues have also affected supplies. More than 80% of the world’s semiconductor production is centred in Taiwan and Korea. Taiwan recently experienced its worst drought in 50 years, affecting production, and factory fires in Korea also harmed output. In the US heavy storms in Texas in 2021 forced a major chip producer to shut down factories.

Even the blocking of the Suez Canal for six days by the Ever Given last year had an impact, delaying chip supplies from the Far East to manufacturers in Europe.

The solution to the shortage is to build new factories. However, not only does this take a lot of time but some manufacturers are wary of investing huge amounts in new facilities for fear that demand will drop away. Professor Yoffie told Wired: “If you look at the history of the semiconductor industry, there are surges in profitability and price followed by spectacular down cycles.

“What we just don’t know is whether this ongoing growth in demand will continue.”


5.1 The end of Italy’s Mario Draghi illusion – The Telegraph

[…] For once the Italian economy has outperformed the German economy, driven by fiscal stimulus of New Deal proportions. But the task is enormous and he has run out of time.

Output is still five percentage points below where it was in 2008. He has yet to bed down the reforms needed to lift Italy from number 58 in the World Bank’s (discontinued) ease of doing business league, or number 68 in the Heritage Foundation’s economic freedom index.

Investors face the serious probability of an anti-Brussels hard-right coalition by early next year, coming just as the European Central Bank tapers bond purchases and pulls away the critical prop for the Italian debt market.

At that point Italy will be on its own again, with a post-Covid debt load of 155pc of GDP, a step-change higher than it was before the eurozone debt crisis. This must be financed in a world of rising real interest rates.

If there is any conclusion to draw from last week’s power struggle over the election of a new Italian president – culminating in a status quo holding action – it is that the country’s permanent mandarin establishment has failed to keep the lid on the seething cauldron in Rome. The demons of Italian politics are loose again.

“The whole process has been extremely painful. It revealed that there is no trust and that Draghi’s government is going to be internally unstable,” said Luigi Scazzieri from the Centre for European Reform.

Investors must weigh the risk that Matteo Salvini’s nationalist Lega party will jump ship, withdrawing support in order to revive his old image as the anti-system, anti-woke, right-wing bulldozer, and man of the people, before the next vote.

A veteran Italian banker in Rome told me that insiders already know that Mr Draghi’s magic spell has irreversibly broken, even if bond spreads have yet to reflect the new reality.

[…] He said the EU Recovery Fund has been oversold as a transforming bonanza by an Italian political class and media that struggles to understand macroeconomic scale. “It is less than they think and I doubt it is going to make much difference. There are a lot of constraints on the money and all it does is get Italy deeper into debt,” he said.

Just €70bn of the total €200bn earmarked for Italy over six years comes as grants. The rest comes as loans that must be repaid. Italy will receive around €40bn over the next year (2.2pc of GDP) but the country is a net contributor to the EU budget, so to some extent it is lending to itself.

The net transfer is around 0.7pc of GDP annually for three years before tailing off.

It is the necessary lubricant for Mr Draghi’s heroic attempt to reinvent the Italian state, the crucial factor missing a decade ago when the Monti government tried to push through reforms in the middle of a violent contraction.

[…] “Draghi has a window of six to nine months. He is speeding everything to push through as many reforms as he can with two cabinet meetings a week,” said Lorenzo Codogno, former chief economist at the Italian treasury and now at LC Macro.

He aims to unclog the courts, reform the antediluvian civil service, make the pension system less ruinous, and close Italy’s digital gap. But this is a decade-long task and he will soon be gone, unless the country dispenses with elections altogether.

Italy has been under a technocrat government several times over the last 20 years. What these regimes all have in common is a suppression of politics for the sake of Italy’s euro membership, the sacred cow of the economic and media elites.

[…] Former EU Commissioner Mario Monti was parachuted into Rome to push through budget cuts and pension reforms largely dictated by the EU authorities.

His appointment did not breach the letter of the law but was denounced by many as a disguised constitutional coup.

The experiment failed. Italy’s bond market blew up anyway. The damage done over those years led to a democratic revolt in 2017 when insurgent parties of left and right swept away the old order – or seemed to do so – vowing to flout EU fiscal rules and calling vaguely for a return to the lira in what can only be termed a collective vaffanculo to Berlin and Brussels.

[…] It was clear to most who covered the election that the Italian people voted for total regime change after two decades of cosmic gloom and negative real GDP growth in per capita terms.

[…] The appointment of Mario Draghi as premier was not a coup. Constitutional niceties were again upheld. You can argue that he is popular, and that Italians are largely content to let him handle both the pandemic and fiscal ties with the EU.

But it is lost on nobody that if an election were held today, polls suggest that Fratelli leader Giorgia Meloni would be the next prime minister of Italy, at the head of a ultra-right coalition with Salvini’s Lega and enough seats to command an absolute majority.

[…] It has become a soft-money institution that is currently soaking up Italian debt and serving the Italian national interest. But quantitative easing cannot go on forever.

The ECB’s position will become untenable as central banks tighten in the rest of the world – and not just the Anglo-Saxons.

[…] Italy today has a current account surplus near 4pc of GDP. It no longer has an obviously overvalued exchange rate against northern Europe.

But it achieved much of this by crushing investment, making it even harder for the country to break out of its bad equilibrium and grow its way out of debt.

Mr Draghi has belatedly tried to reverse this fatal policy mix but not even he can deliver a miracle cure under the twin constraints of time and the Italian constitution.

Sooner or later, the markets will have to come to terms with the end of the Draghi illusion.

Comment: It’s one of the longest articles we have used in a while, but also one of the most important. Ambrose Evans-Pritchard sums up why Italy is such a significant geopolitical and macro risk in Europe. Even though politicians managed to keep Draghi as prime minister until at least 2023, investors are starting to look forward to an election that could see domination from the right-wing. If that were the case, all eyes will be on Italy’s economic fundamentals again as its economy won’t be able to benefit from EU grants anymore – even if the current coalition were to continue, that would eventually become a problem.

What Italy needs it a complete overhaul. Right now, it is keeping the ECB from raising rates as it is entirely funded by the bank. If the bank were to end QE and raise rates, Italy could trigger a sovereign debt crisis resulting in massive uncertainty and a possible default or even euro exit as a solution.

In order to avoid that, Italy needs to improve its economic productivity as we have argued in the past. Reduce regulations, improve access to affordable energy, and open up new trade opportunities.

Time is limited, and the clock is ticking as there soon may be no way around ending QE and rate hikes, which will make implementing reforms much harder. 

For now, the spread between Italian 10Y bond yields and German bond yields remains subdued below 1.4%. As investors trust that the ECB can stick to its accommodative policy without being forced to change the course. Saturday’s Italian election outcome also helped to calm some nerves.