London Daily

Focus on the big picture.
Sunday, Oct 12, 2025

Italy political turmoil a headache for Europe's central bank

Italy political turmoil a headache for Europe's central bank

Italian Prime Minister Mario Draghi’s offer to resign has sent unsettling ripples through financial markets, bringing back bad memories of Europe’s debt crisis a decade ago and complicating the European Central Bank’s job as it raises interest rates for the first time in 11 years to combat record inflation.
Draghi, a former ECB president, has pushed policies meant to keep Italy’s high levels of debt manageable and boost growth in Europe’s third-largest economy. He suggested Wednesday that he was open to staying in power, but the threat of political changes as borrowing costs increase have raised concerns that the 19-country eurozone could head into another crisis.

It’s a headache for the ECB as it seeks to return interest rates from sub-zero to more normal levels starting Thursday — without setting off bond-market chaos in a country with debt at 150% of economic output. The ECB has said it will raise rates a quarter-percentage point, though some analysts aren’t ruling out a half-point increase.

The Frankfurt-based ECB will join the U.S. Federal Reserve, Bank of England and other central banks worldwide that have already raised rates several times to tame runaway inflation. But the ECB doesn’t want jittery markets sending up the borrowing costs of some euro member countries beyond what’s justified by their economic strength.

The bank’s task is already hard enough with predictions growing of a recession next year due to exorbitant oil and natural gas prices fueled by the war in Ukraine.

So along with the rate increase, ECB President Christine Lagarde is expected to announce a financial backstop aimed at capping borrowing costs for governments and companies in eurozone countries that are less financially solid than the others.

It’s a hassle unique to the ECB because it oversees 19 countries that are in different financial shape but use one currency, which has plunged to its lowest level against the dollar in 20 years.

“The Fed and the Bank of England don’t have this problem,” said Maria Demertzis, interim director of the Bruegel think tank in Brussels. “The borrowing costs for each country when they issue debt is different, because the underlying outlook is different.”

The ECB’s goal is to avoid a replay of 2011 to 2012, when Italy’s borrowing costs spiked to around 7%, driven by a so-called bond-market death spiral, where rising borrowing costs raise fears a government won’t repay their debt, in turn raising borrowing costs even higher.

The vicious circle was broken by Draghi pledging as ECB chief to “do whatever it takes” to preserve the euro, followed with a promise that the bank would buy the bonds of countries facing excessive borrowing costs if needed. That backstop calmed the market so well that it never had to be used. But it came with tough conditions that might make it unappealing to governments.

The ECB’s new backstop will have conditions but probably less onerous ones. It would consist of a promise to buy an indebted country’s bonds, which drives down borrowing costs if market interest rates rise to unjustified levels.

In recent days, borrowing costs for Italy and other less financially solid eurozone countries such as Spain and Portugal have risen compared with financially solid Germany, the benchmark.

Italian 10-year bonds now yield 3.4%, about 2.2% higher than their German equivalent. Italy’s borrowing costs are not excessive at that level, but the idea is to keep them that way because market sentiment can turn suddenly.

Demertzis said that as interest rates go up, they’re transmitted differently to the borrowing costs of each country.

“So now that we are in the part of the interest rate cycle where rates are going to have to go up, the problem is that borrowing costs will accelerate for Italy and will not accelerate for Germany,” she said.

If Italy can’t borrow affordably, it could turn to the eurozone’s bailout fund, but it would be much harder to rescue than Greece was a decade ago because Italy is much bigger.

The trick for the ECB will be to reassure markets while not encouraging reckless spending by governments or violating legal restrictions on directly financing governments.

“Any sense that the ECB is dragging its feet, or that the final outcome won’t be effective enough, will see fragmentation concerns rush back onto the agenda, fanning the flames of an altogether more worrying fall in the euro,” wrote Neal Shearing, chief economist at Capital Economics.

“Ten years after Draghi’s pledge to do whatever it takes, Christine Lagarde risks repeating history. She must avoid drifting into another crisis that would ultimately require her to make a similar pledge to her predecessor,” he said in an analyst note.

Italy’s political crisis, playing out in Parliament after the president rejected Draghi’s offer to resign over a divide in the coalition government, follows 17 months of relative stability. Draghi rolled out an ambitious pandemic recovery program aimed at improving long-term economic growth — the real answer to keeping Italy’s debt manageable.

The 190 billion-euro plan backed by common EU borrowing will add some debt but is intended to more than make up for it because strong growth shrinks the size of debt relative to the economy.

Italy’s debt, second highest in the eurozone after Greece, fell 4.5% in 2021 because of the country’s strong growth rebound.

Greek debt is less of an issue, Demertzis said, because it’s mostly owed to public institutions after Greece’s three bailouts during the debt crisis — and therefore isn’t exposed to market selloffs.

Draghi’s government has begun passing recovery proposals like digitizing and improving government services and streamlining a cumbersome legal system criticized for years as a drag on businesses. It also plans to increase day-care slots so more women can enter the labor force, accelerate the transition to renewable energy and extend high-speed rail and internet to more areas of the country.

But if Draghi’s coalition breaks apart and is replaced by a government less committed to pressing ahead with the reforms, markets could begin to doubt its prospects for economic growth.
Newsletter

Related Articles

0:00
0:00
Close
California County Reinstates Mask Mandate in Health Facilities as Respiratory Illness Risk Rises
Israel and Hamas Agree to First Phase of Trump-Brokered Gaza Truce, Hostages to Be Freed
French Political Turmoil Elevates Marine Le Pen as Rassemblement National Poised for Power
China Unveils Sweeping Rare Earth Export Controls to Shield ‘National Security’
The Davos Set in Decline: Why the World Economic Forum’s Power Must Be Challenged
France: Less Than a Month After His Appointment, the New French Prime Minister Resigns
Hungarian Prime Minister Viktor Orbán stated that Hungary will not adopt the euro because the European Union is falling apart.
Sarah Mullally Becomes First Woman Appointed Archbishop of Canterbury
Mayor in western Germany in intensive care after stabbing
Australian government pays Deloitte nearly half a million dollars for a report built on fabricated quotes, fake citations, and AI-generated nonsense.
US Prosecutors Gained Legal Approval to Hack Telegram Servers
Macron Faces Intensifying Pressure to Resign or Trigger New Elections Amid France’s Political Turmoil
Standard Chartered Names Roberto Hoornweg as Sole Head of Corporate & Investment Banking
UK Asylum Housing Firm Faces Backlash Over £187 Million Profits and Poor Living Conditions
UK Police Crack Major Gang in Smuggling of up to 40,000 Stolen Phones to China
BYD’s UK Sales Soar Nearly Nine-Fold, Making Britain Its Biggest Market Outside China
Trump Proposes Farm Bailout from Tariff Revenues Amid Backlash from Other Industries
FIFA Accuses Malaysia of Forging Citizenship Documents, Suspends Seven Footballers
Latvia to Bar Tourist and Occasional Buses to Russia and Belarus Until 2026
A Dollar Coin Featuring Trump’s Portrait Expected to Be Issued Next Year
Australia Orders X to Block Murder Videos, Citing Online Safety and Public Exposure
Three Scientists Awarded Nobel Prize in Medicine for Discovery of Immune Self-Tolerance Mechanism
OpenAI and AMD Forge Landmark AI-Chip Alliance with Equity Option
Munich Airport Reopens After Second Drone Shutdown
France Names New Government Amid Political Crisis
Trump Stands Firm in Shutdown Showdown and Declares War on Drug Cartels — Turning Crisis into Opportunity
Surge of U.S. Billionaires Transforms London’s Peninsula Apartments into Ultra-Luxury Stronghold
Pro Europe and Anti-War Babiš Poised to Return to Power After Czech Parliamentary Vote
Jeff Bezos Calls AI Surge a ‘Good’ Bubble, Urges Focus on Lasting Innovation
Japan’s Ruling Party Chooses Sanae Takaichi, Clearing Path to First Female Prime Minister
Sean ‘Diddy’ Combs Sentenced to Fifty Months in Prison Following Prostitution Conviction
Taylor Swift’s ‘Showgirl’ Launch Extends Billion-Dollar Empire
Trump Administration Launches “TrumpRx” Plan to Enable Direct Drug Sales at Deep Discounts
Trump Announces Intention to Impose 100 Percent Tariff on Foreign-Made Films
Altman Says GPT-5 Already Outpaces Him, Warns AI Could Automate 40% of Work
Singapore and Hong Kong Vie to Dominate Asia’s Rising Gold Trade
Trump Organization Teams with Saudi Developer on $1 Billion Trump Plaza in Jeddah
Manhattan Sees Surge in Office-to-Housing Conversions, Highest Since 2008
Switzerland and U.S. Issue Joint Assurance Against Currency Manipulation
Electronic Arts to Be Taken Private in Historic $55 Billion Buyout
Thomas Jacob Sanford Named as Suspect in Deadly Michigan Church Shooting and Arson
Russian Research Vessel 'Yantar' Tracked Mapping Europe’s Subsea Cables, Raising Security Alarms
New York Man Arrested After On-Air Confession to 2017 Parents’ Murders
U.S. Defense Chief Orders Sudden Summit of Hundreds of Generals and Admirals
Global Cruise Industry Posts Dramatic Comeback with 34.6 Million Passengers in 2024
Trump Claims FBI Planted 274 Agents at Capitol Riot, Citing Unverified Reports
India: Internet Suspended in Bareilly Amid Communal Clashes Between Muslims and Hindus
Supreme Court Extends Freeze on Nearly $5 Billion in U.S. Foreign Aid at Trump’s Request
Archaeologists Recover Statues and Temples from 2,000-Year-Old Sunken City off Alexandria
China Deploys 2,000 Workers to Spain to Build Major EV Battery Factory, Raising European Dependence
×