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• European sovereign bond market tensions have again picked up, with Italy being at the epicenter of investors’ worries.
• A permanent debt servicing cost close to current levels of around 7% will keep Italy’s debt-to-GDP ratio on an upward trajectory.• The size of the Italian government bond market sets the biggest threat for the eurozone, with systemic implications for the world economy and global financial markets.• The successful execution of the austerity package and the implementation of structural reforms by the new government of Mario Monti are necessary to increase confidence in the Italian debt and, thus, lower borrowing costs.
• However, past experience of Greece, Ireland and Portugal has shown that once a eurozone country has come to the bonds’ market spotlight, it is very difficult to regain market access in time to avoid a credit event without external financial assistance.