How Italian turmoil in the bond markets could spark a domino effect across Europe

Banks in major European economies could be severely hurt by political developments in Italy given their exposure to Italian debt, with France’s lenders leading the potential losses.

Recent political turmoil in Italy has increased the borrowing costs for the euro zone’s third-largest economy, but it has also raised questions about potential contagion to other countries. Calls from certain Italian politicians to leave the euro zone and to challenge European fiscal rules sparked concerns over a potential break up between Italy and the rest of the bloc, which would ultimately question the future existence of the euro area itself.

At the same time as Italy’s government found it more expensive to fund itself, those who already owed Italian debt found their investments riskier and less profitable. This is because when yields rise it means there’s a higher perceived risk. It also means that the chances of seeing a return on their Italian bonds are reduced. So, troubled times for Italian debt also extends to those holding it too.

“Italy is by far the biggest threat to euro area stability … The economy suffers from a dangerous mix of weak growth, poor competitiveness, high public debt and a struggling banking sector,” Shweta Singh, the managing director at TS Lombard, said in a report published Monday.

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