Back in April I wrote this:

I hate to say it, but I fear that we are in for a new round of euro zone troubles.

My key concern is that monetary conditions in the euro zone remains far to tight, which among other things is reflected in the continued very low level of inflation expectations in the euro zone. Hence, it is clear that the markets do not expect the ECB to deliver 2% inflation any time soon. As a consequence, nominal GDP growth also remains very weak across the euro zone.

…And Spain is not the only euro zone country with renewed budget concerns. Hence, on Friday Italy’s government cut it growth forecast for 2017 and increased it deficit forecast. Portugal is facing a similar problem – and things surely do not look well in Greece either.

So soon public finances problem with be back on the agenda for the European markets, but it is important to realize that this to a very large extent is a result of overly tighten monetary conditions. As I have said over and over again – Europe’s “debt” crisis is really a nominal GDP crisis. With no nominal GDP growth there is no public revenue growth and public debt ratios will continue to increase.

…So be careful out there – soon with my might be in for euro troubles again.

I think we have moved closer to this “euro spasm” and it is now particularly showing up in the form of worries over the state of the Italian banking sector, which adds to the concerns that the markets already have about the state of Italian public finances.

So while the global financial markets seem to been recovering from the initial shock from the outcome of the United Kingdom’s EU referendum and even though the EU system clearly still is in shock from the ‘Brexit’ decision it is clear that the global financial markets seem to have stabilised after a short-lived spasm.

However, for the EU it is far too early to conclude that we are out of the woods. In fact, Brexit might not be the biggest worry for the EU. Instead the next big worry might be Italy.

Italy – 15 years without growth

Italy is without a doubt one of Europe’s absolute worst performing economies over the past decade and recently fears over the state of the Italian banking sector has yet again resurfaced and in the direct aftermath of the Brexit crisis Italian Prime Minister Matteo Renzi has suggested a major bailout package for the Italian banking sector.

However, such plans would likely be in conflict with EU’s new rules that basically means such bailouts should be financed primarily by depositors and creditors rather than by taxpayers so for now it looks like Renzi cannot get an ok from the EU for a new banking rescue package. That, however, doesn’t change the fact that the Italian banking sector is in serious trouble and Italian bank shares have been more than halved in value this year.

The Italian banking sectors’ trouble has little to do with the Brexit vote. Rather the main reason the Italian banking sector is under water is the same reason why Italian public finances are a mess – lack of economic growth.

Hence, there essentially hasn’t been any recovery in the Italian economy since 2008. In fact, real GDP is today nearly 10% lower than it was at the start of 2008 and even worse – real GDP today is at the same level as 15 years ago! 15 years of no growth – that is the reality of the Italy economy.

And have a look at the nominal GDP growth in Italy:

In the decade prior to 2008 Italian NGDP grew more or less at a straight line. However, since 2008 actual nominal GDP level has fallen massively short the pre-crisis trend.

There are numerous reasons for Italy’s lack of (both real and nominal) growth. One thing is the fact that Italy is in a currency union – the euro area – in which it should never had become a member. Italy’s deep crisis warrants massive monetary easing – in other words Italy needs a much weaker ‘lira’, but Italy no longer has the lira and as a consequence monetary conditions remains too tight for Italy.

Furthermore, Italy is marred by serious structural problems – for example rigid labour market regulation and negative demographics. As a consequence, the growth outlook remains quite bleak.

And even though growth has picked up slightly over the past year it is hardly impressive and latest round of market turmoil has likely further dented Italian growth and Italy could easily fall into recession again in the coming quarters if the banking trouble escalates.

With no growth is it hard to see both private and public debt levels coming down in any substantial way and as a consequence we are very likely to soon again see renewed worries about both the Italian banking sector and Italian public finances. As consequence the EU’s next headache might very well be Italy.