Italy’s debt dynamics worsen

Prior to the announcement of the second rescue package for Greece, we noted that anything other than a very decisive response by European policymakers could prompt Italy and Spain to be dragged deeper into the crisis, with catastrophic consequences. But even we have been a bit surprised at just how short-lived the relief for Italy and Spain has been. The recent rise in Italian bond yields might not be disastrous in the near-term. But if bond yields remain at their current levels and the Italian economy fails to expand at anything better than a very sluggish pace, Italy may eventually be forced to restructure its debts.