Five things to look out for in Spain and Italy that could further impact the eurozone

The past few days have been unhappy for European markets. On Friday the euro was at a six-month low, and there was a widespread selloff of equities. Forecasts for growth were being downgraded: as Oxford Economics put it, “Euroboom turns to Eurogloom”.

The reason is politics. There is a looming clash between the new populist Italian government and the EU, and there is a populist revolt in Spain, which will probably lead to a snap election.

Politics is a national sport, not an international one, but it has international – or at least regional – consequences. So the question for the rest of us is whether this is just part of the normal noise of European politics – the speeches, the votes, the rows, the pictures of politicians getting out of black Mercedes and so on – or whether this is something bigger. Is this just more “muddle through”?

The chances are that the new Italian, and probably Spanish, governments will eventually fall in line with EU rules with a bit of fuzziness round the edges. Greece, at huge cost to its people, did so. But how should the rest of us gauge the tensions? Is Italy’s membership of the euro really at risk? Here are some ideas.

There is one very simple measure of what the markets think, and that is the spread between Italian government debt and the equivalent German bonds. (The nickname of Italian government bonds is BTPs, while German bonds are called bunds.)

Italian debt yields more than German because it is seen as more risky. In the last week of April the gap for 10-year debt was less than 1.2 per cent, but on Friday it had risen to more than 2 per cent. It is, you could say, a gauge of fear: people have become more scared. But to put this in perspective, the gap is much less than it was in 2012, when it was more than 5 per cent.

A second measure is popular support for the euro in Italy and Spain. Polls throughout Europe tell us that the euro is popular. Its strongest support is in Ireland, but even in Greece more than half the people want to keep it. The new Italian government has weakened its stance on leaving the euro, and provided support for membership remains above 50 per cent it is hard to see Italy leaving in a direct way. What it may do is create a parallel currency to help fund a more expansionary fiscal policy.

How would it work? Here is a good commentary on Reuters. “The Treasury would print billions of euros of non-interest-bearing, tradeable securities which could then be used by recipients to pay taxes and buy any services or goods provided by the state, including, for example, petrol at stations run by state-controlled oil company ENI.”

Next thing to look for will be how far Italy carries through its tax and spending plans. These are quite radical: cuts in income tax to 15 per cent and 20 per cent and a citizen basic wage (though only to low-paid workers and unemployed). What will be credible? UBS, the Swiss bank, has just put out a paper suggesting that fiscal package equivalent to 1 per cent of GDP would be accepted as reasonable by the markets. That seems to me to be a rather sensible benchmark.

Finally, a word about Spain. It has pulled back from the debt abyss of six years ago, and is now achieving strong growth – more than 3 per cent last year. No one knows what will happen to Spanish politics, so I suggest the thing to look for is simply whether the present solid growth numbers continue, and the single most useful indicator is unemployment.

Spanish unemployment crept up to 16.74 per cent in the last quarter, though well down on a year ago when it was more than 18 per cent. If unemployment in Spain starts to rise further, expect political trouble, quite aside from the wastage of human capital and the misery for all.

My own feeling is that the next eurozone crisis is still some way away, and will not happen until global interest rates really start to climb. Meanwhile, Italy is the country to watch.