Italy's turn to make waves

COUNDOWN TO EMU 642 DAYS TO GO

Italy rather than Germany hogged the EMU limelight this week. Speculation about German borrowing gave way to the details of Italy's latest mini budget, launched on Thursday and designed to bring Italian borrowing down towards the 3 per cent of gross domestic product limit ordained by the Maastricht treaty.

Meanwhile, the disagreements between German politicians and bankers over European monetary union were pushed off the agenda by the Italian Foreign Minister Lamberto Dini - who became the first key politician in a pro-EMU country to talk openly about delaying the single currency.

In the face of such apparently meaty events, the markets might have been expected to react, as traders delivered their verdicts on whether the project was more likely to be delayed or not, and particularly on the likelihood of Italy being included.

In fact, by the end of the week very little had changed. The Italian lira did have an extremely hard time at the beginning of the week, as markets reacted to Mr Dini's comments.

Any possibility of a delay to EMU tends to rebound badly on the so-called peripheral countries, particularly Italy and Spain, as traders who have been betting on those economies becoming hitched to Germany start to get nervous.

Philip Chitty of ABN Amro said: "It only took one comment for the markets to go ballistic. It shows that all it will take is one slightly more substantial remark for the markets to seriously move."

The return to calm in the markets by the end of the week was put down by analysts to Mr Dini's relative lack of importance in the EMU game.

Martin Brookes of Goldman Sachs said: "Dini wasn't speaking for the Italian government. Prime Minister Prodi is still talking about 1999."

Nevertheless, this shows what is at stake for Italy. Mr Chitty said: "There is no middle ground here. Either Italy makes it and Italian bonds converge towards German bonds, or Italy doesn't and bonds go stratospheric. It's a binary game."

In the circumstances, the announcement that the Italian government is proposing a mini budget which aims to cut the deficit by 15.5bn lire (pounds 6.3bn) might have been expected to provoke a market reaction, especially given the impact it should have on Italy's ability to meet the Maastricht criteria.

Mr Brookes suggested the budget proposals could reduce Italy's deficit to 3.5-4 per cent of GDP, close to the Maastricht limit. But this was in line with expectations and the markets hardly reacted at all. The news, therefore, did little to change previous market expectations of Italy joining EMU.

However, even if Italy appears to be winning the "binary game" and bringing its deficit down, analysts pointed out that the uncertainty is not over for the markets.

"The Italian mini budget actually heightens the conundrum: what will Europe do if Italian and German borrowing figures come in close together?", asked Mr Brookes. German hostility to a single currency which includes Italy in the first wave is well known.

The next important clues to EMU's future on the economic front won't emerge for several weeks, when the first data about German economic performance this year will be released. At that stage it will be clearer whether Germany itself can meet the Maastricht criteria without further action.

But for political news we may not have to wait so long. Next weekend Europe's finance ministers and central bankers meet to discuss monetary union at an informal meeting of Ecofin, a committee of the European Union. This should provide plenty of opportunity for bigger fish than Mr Dini to make waves if they want to.