After two months of political stalemate, Italy has a new prime minister. Italy’s President named Enrico Letta, of the center-left Democratic Party, premier and asked him to form a government. Letta announced that he intends to fight the move towards austerity in Europe — investors applauded and Italy’s borrowing costs fell.
This reaction underscores an important change in sentiment. At the start of the euro zone debt crisis, investors demanded that heavily indebted countries like Spain, Portugal, Ireland, Italy and Greece get their public finances under control. They punished wayward governments by dumping their bonds and driving up their borrowing costs. Creditor countries — led by Germany — demanded deep cuts in public spending and radical economic reform.
But the tide against this austerity has clearly turned. And the reaction to the new Italian prime minister demonstrates this. Investors now see low growth as the primary problem. Simon Tilford of the Centre for European Reform says investors are more likely to reward a government that stimulates growth and punish one that cuts:
“All investors worry whether they are going to get their money back,” says Tilford. “If they think they are not going to get their money back because an economy is performing so poorly that it’s not going to be able to pay its debts, then they are going to charge more to lend to that country.”
The pressure to lighten up on the austerity in Europe seems likely to grow, not least in Spain where unemployment has just hit 27.2 percent and — critics argue — austerity is largely to blame.