Italy on the ropes after Greek vote call stuns markets

ROME—Italy suffered heavy market losses on Tuesday as a shock referendum announcement from Greece threatened to undermine Silvio Berlusconi’s attempts to stave off contagion from Europe’s debt crisis.

Stocks in Milan crashed 7.07 percent and two-year and five-year bond rates hit record highs, while the spread between yields on 10-year government bonds and benchmark German ones widened to a record high of 455 basis points.

“Spread goes sky-high, stocks go to hell,” said the Italian financial news website firstonline.info, calling Greek Prime Minister George Papandreou’s announcement that Athens will hold a vote on its bailout deal “a catastrophe.”

The Greek move sparked an angry reaction from the Italian prime minister.

“There is no doubt the Greek decision to hold a referendum on the European Union’s rescue plan is having a negative effect on the markets. This is an unexpected decision that generates uncertainties,” Berlusconi said.

He added that the Italian government was working on economic measures to be outlined at the G20 summit in Cannes this week and promised to implement them “with the awareness, the discipline and the speed demanded by the situation.”

The havoc on the markets prompted the European Central Bank to intervene by buying up Italian bonds, market sources said, on the same day that former Bank of Italy governor Mario Draghi takes over as the ECB’s president.

The ECB intervention initially slightly lowered the yield on 10-year government bonds but the effect was short-lived and the rate shot up to 4.33 percent later on Tuesday.

The yield was coming perilously close to its highest ever level of 6.397 percent reached in August when the government was forced to adopt emergency austerity measures and the ECB first started propping up Italian bonds.

Italy’s center-right government has since come under ever greater pressure from its eurozone partners to implement reforms to cut debt and boost growth but has been held back by growing infighting within the ruling coalition.

Italy has one of the lowest growth rates and highest debt levels in Europe, although its public deficit is lower than that of many of its neighbors.

Analysts warned high bond yields risked making Italy’s debt unsustainable – a dangerous spiral that could ultimately force Italy, the eurozone’s third-largest economy, to seek a bailout like Greece, Ireland and Portugal.

“If we reach 7.0 percent, we’re one step from default,” said Danilo Caselli, the director of the Milano Finanza-Dow Jones financial news agency.

Nicola Rossi, an opposition senator and economist, said on Italian news channel SkyTG24: “We all know that when our borrowing rate is close to seven percent our debt risks becoming unsustainable.

“The problem is that Italy is the weak link in the euro chain, so we are under particular scrutiny,” he said.

Rene Defossez, a bond strategist at French bank Natixis, however, said investor concerns over Italy were exaggerated.

“Italy is not Greece. It’s a major industrialized country with one of the highest primary surpluses in the eurozone,” he said.

But Defossez also said the referendum announcement was “very, very bad news since it delays a resolution of the crisis by several months.”

Business daily Il Sole 24 Ore said: “The situation – specifically our own – has deteriorated due to hesitation. We have got ourselves in a mess on our own and only we can and must get out of it.”