Draghi Says He Will Resign as Prime Minister; Italian Bonds Tank

© Reuters.

By Geoffrey Smith 

Investing.com -- Mario Draghi is to resign as Prime Minister of Italy, after losing the support of one of the country's largest political parties from his broad coalition government.

"The conditions are no longer in place for me to carry on," Draghi told reporters. "I will tender my resignation to the president this evening." 

The news is a blow to Italian bonds and stocks, which have benefited from the presence of the widely respected former President of the European Central Bank during his time at the helm. 

Italian bond yields have surged in the last two days after the Five Star Movement (M5S) said it could no longer support the government, dissatisfied with what it saw as inadequate support for lower-income people in the face of spiraling inflation. The party, led by former Prime Minister Giuseppe Conte, had already split over Draghi's policy of sending arms to Ukraine. 

The yield on the benchmark Italian 10-Year bond lurched higher again on the news, rising 12 basis points to a two-week high of 3.51%. The spread to the comparable German 10-Year bond, widened to 234 basis points, the widest since June and more than double where it stood at the start of the year. 

The FTSE MIB stock index, meanwhile, had earlier closed down 3.4% at its lowest since November 2020. 

Draghi’s resignation comes only a week before the European Central Bank is set to raise its key interest rates for the first time in a decade, raising borrowing costs for one of the developed world’s most heavily indebted countries.

The rise in borrowing costs will prove especially challenging given that Italy's economy is fast sliding into recession, with energy prices rocketing and an increasingly severe drought hurting both the agriculture sector and hydroelectric power generators. 

When its Governing Council meets next week, the ECB is set to discuss what has been termed its 'anti-fragmentation tool,' a way of capping the spread between Germany and other Eurozone members who are perceived as higher credit risks. That includes not just Italy, but countries such as Portugal, Spain and Greece, where the pandemic has undone much of the improvement in their public finances since they were forced to take bailouts a decade ago.

The head of Germany's central bank, Joachim Nagel, said earlier this week that he wouldn't support any new program to cap bond yields unless it were tied to appropriate conditionality, setting the stage for a revival of the kind of haggling over official support that characterized the euro crisis a decade ago. One crucial difference between then and now is that the Eurozone was flirting heavily with deflation at the time, allowing the ECB to be aggressive in easing monetary policy to support the currency bloc's weaker members. That is not the case today, when Eurozone inflation is running at a record high 8.6%.