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Hermes: Italy and Europe – the integration dilemma

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Hermes: Italy and Europe – the integration dilemma

While Italy’s short-term economic outlook includes some positive elements, material downside risks loom amid high policy uncertainty. In her latest Ahead of the Curve, Silvia Dall’Angelo, Senior Economist at Hermes Investment Management, argues the Italian situation is a symptom of deep-rooted malaise and requires a credible and concerted response.

 Italy’s recent political imbroglio reignited the debate over the European Union’s (EU) future and the viability of the European single currency within its current institutional framework.

While the situation has normalised, the landscape in Italy remains fragile. It is emblematic of the challenges the Eurozone is facing in a new political era. This new political backdrop emphasises national sovereignty, has an inward-looking approach and favours centrifugal forces, posing hurdles to European integration.

Effects of the crisis

Italy’s double-dip recession – the global financial crisis in 2008, followed by the European Sovereign Debt Crisis in 2012/13 – was particularly severe, as the country was ill-equipped to deal with it in the first place. The typically short-lived political cycle – with 65 administrations at the helm since World War II – has favoured wasteful public spending and quick fixes, rather than long-sighted structural reforms. In this context, public debt grew quickly, thereby reducing the fiscal space available at times of crisis.

Today, Italy is still feeling the effects of the double-dip: Italian real GDP is 5% below the levels that prevailed before the 2008 crisis (see chart). The unemployment rate has declined, but at 11%, it is still high. Additionally, youth unemployment is elevated at about 30%.

Since the double-dip recession, real GDP has recovered in major Eurozone countries, with the exception of Italy 

Short-term positives and challenges

The short-term economic outlook includes some positive elements, but material downside risks loom amid high policy uncertainty, both domestically and externally.

In the last couple of years, the recovery has accelerated somewhat: annual GDP growth came in at 1.5% in 2017, which, by recent Italian standards, is a decent number. However, this is still below the growth rates that are currently prevailing in the rest of the Eurozone.

The sustainability of Italy’s recovery seems limited should support from external demand falter. Indeed, the fundamentals for domestic demand are mixed. Real disposable income has improved slightly, reflecting improvements in the labour market and contained consumer inflation. Yet, the labour market is still weak. Employment has improved in recent years, but the quality of jobs has deteriorated.

While the European Central Bank’s accommodative monetary policy has also contributed to Italy’s recovery in recent years, the main hurdle to credit expansion in Italy is the condition of the banking system, which is still burdened by a high amount of non-performing loans. The situation has improved in the last couple of years: net non-performing loans have declined to 3% of GDP from a peak of more than 5% of GDP in 2015-16.

 Domestic politics and policies

The main risks for the Italian situation stem from domestic politics and policies. The new coalition populist government is inherently fragile. Its main political components are rooted in two parties that have different approaches, different goals and a different electoral base. This could lead to inconsistent and ineffective government action and, more importantly, tensions within the coalition that could compromise the tenure of the government. In this respect, the risk of new elections sometime next year leading to renewed political instability is significant.

Importantly, initial rumblings about Italy’s euro membership have quickly dissipated and high-level government officials have stressed the country’s commitment to the single currency. Public debt amounts to about €2.3tn and 70% of it is held domestically. In general, Italy has a solid net external international position – with net international liabilities amounting to only around 7% of GDP in Q4 2017. Therefore, it makes little sense for the country to exit the euro and renege on its external debt.

While it is unlikely that all of the fiscal measures promised by the coalition will come to pass in the upcoming budget, even a partial inclusion would lead to fiscal slippage. Financial markets have already demanded greater compensation for holding Italian debt since the bumpy government formation a month ago, as they now perceive it as riskier. Indeed, Italy is running a high public debt of more than 130% of GDP and the path to sustainability is a very narrow one.

 Advancing European integration

The Italian situation is a symptom of deep-rooted malaise: it requires serious consideration and a credible and concerted response from both domestic and European politicians.

Domestically, a combination of limited and targeted fiscal stimulus and structural reforms would be helpful. There are quite a few low-hanging fruit: the new government could make the judiciary system more efficient, simplify the tax system and favour business creation and competitiveness in several sectors, services notably. Fiscal space should be used to lower taxes on labour and to spur investment in innovation, education and infrastructure. However, it is unclear whether the current Italian government has the political capital and the vision needed to pursue structural reform and targeted fiscal stimulus by implementing reforms that are unlikely to pay off in the short term.

In general, despite making some progress since 2009, the gap between core and periphery countries within the Eurozone has persisted – and significant convergence is still far away. This implies that the next crisis is likely to have a disparate impact across different member countries, thereby acting as an asymmetric shock. At present, there is no mechanism in place that can respond effectively to shocks hitting different countries unevenly.

This requires a concerted response: the European integration process needs to advance. European leaders will have to work to fix the shortcomings of the European project, providing a stronger political and fiscal underpinning to the single currency.

Historically, the European integration process has leaped forward at times of crisis. Therefore, the materialisation of the populist threat may act as the catalyst this time. The presence of anti-establishment forces in the Italian government should be a reminder that the general malaise and disillusion should be taken seriously.

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Bitcoin slumps 10% as pullback from record continues

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Bitcoin slumps 10% as pullback from record continues 1

LONDON (Reuters) – Bitcoin slumped 10% on Thursday to a 10-day low of $31,977 as the world’s most popular cryptocurrency continued to retreat from the $42,000 record high hit on Jan. 8.

The pullback came amid growing concerns that bitcoin is one of a number of financial bubbles threatening the overall stability of global markets.

Fears that U.S. President Joe Biden’s administration could attempt to regulate cryptocurrencies have also weighed, traders said.

(Reporting by Julien Ponthus; editing by Tom Wilson)

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A lot of hot air? Investors snap up hydrogen stocks in green frenzy

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A lot of hot air? Investors snap up hydrogen stocks in green frenzy 2

By Elizabeth Howcroft and Thyagaraju Adinarayan

LONDON (Reuters) – An unprecedented rally in “green” hydrogen stocks looks set to extend as investors flock to companies which promise to produce the gas without using fossil fuels, expecting the technology to scale up over the next 10 years to justify rocketing valuations.

Hydrogen is the universe’s most abundant element. It is mostly extracted from fossil fuels, emitting carbon dioxide in the process. “Green” or clean hydrogen requires using electrolysis to split water into its components of hydrogen and oxygen and doing so cheaply is often described as the holy grail of green energy transition.

Share prices of companies in the industry have soared more than 500% in the past year, driven by the rising adoption of zero-emission vehicles, a deadline set by many countries to go carbon-free by 2050 and lately U.S. President-elect Joe Biden’s support for clean energy.

Plug Power, Ceres Power and Fuelcell Energy, which make hydrogen fuel cell systems that power devices ranging from warehouse machines to cars, are leading that charge, jumping 400% to 1,600% in the last year.

“Hot money is flowing towards renewables and clean energy, and there’s been a clear re-rating of valuations in the sector,” said Emmanuel Cau, head of European equity strategy at Barclays.

While a lot of focus has been on hydrogen’s role in the automotive sector, its usage is growing far beyond that.

The European Union plans to scale up renewable hydrogen projects across polluting sectors ranging from chemicals to steel with cumulative investments in renewable hydrogen in the region seen reaching up to 470 billion euros ($570 billion) by 2050, the region’s commission said.

That has fuelled the stocks of electrolyser makers Norway’s Nel and UK’s ITM Power.

“The momentum just keeps going really with this theme,” Ashim Paun, HSBC’s global co-head of climate change and ESG research said on a webinar.

ZeroAvia, a hydrogen plane startup, last month secured $37.7 million in new cash via a funding round led by Bill Gates’ Breakthrough Energy Ventures and from the British government to support its bid to develop zero-emission aircraft.

The frenzy in hydrogen-related stocks has led to some concerns about a bubble, with companies trading at extreme prices based on expectations that their revenue will surge in future, despite worries about possible headwinds for the sector.

Widespread adoption of hydrogen as a fuel for cars is far from a given.

Toyota launched a new hydrogen fuel cell car in December, but it has largely failed to win customers over to the technology amid concerns about a lack of fuelling stations, resale values and the risk of hydrogen explosions.

The momentum behind electric vehicles may be another headwind, said Jonathan Bell, chief investment officer at Stanhope Capital.

“The problem with hydrogen is that sometimes when you have two competing systems, it’s not the better technology that wins, it’s the one that gets market share and the network effect first of all,” Bell said.

UK-based ITM Power, which manufactures the electrolysers needed to make green hydrogen, is trading at a massive seven times its 2030 sales, while rival Nel is relatively cheap at three times 2030 sales, according to HSBC’s calculations.

Some investors may avoid the sector altogether, after a similar burst of enthusiasm two decades ago proved short-lived, and much of the latest excitement around green energy is based on Biden’s policy plans, which are yet to be passed into law.

But no bank is ringing the alarm bells, yet.

JP Morgan analysts advised long-term investors in a recent note to take advantage of any pullback in prices and “take an unorthodox approach to valuation for the next several years” – in other words, not worry about a potential bubble.

Sean McLoughlin, HSBC EMEA head of industrials research, said scarcity value in the market, unprecedented fiscal stimulus, low cost of capital and debt and low yields in other asset classes mean the hydrogen market’s valuation may be justified though he cautioned it was at a “potentially fraught level.”

“There’s a lot of capital that is very ESG-focused chasing a select number of companies that offer this kind of pure play exposure to these future energy trends. So there is a risk that this may unwind.”

($1 = 0.8258 euros)

(This story corrects paragraph 2 to show hydrogen is the universe’s most abundant element, not earth’s)

(Reporting by Thyagaraju Adinarayan and Elizabeth Howcroft, additional reporting by Julien Ponthus; editing by Rachel Armstrong and Emelia Sithole-Matarise)

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BlackRock to add bitcoin as eligible investment to two funds

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BlackRock to add bitcoin as eligible investment to two funds 3

(Reuters) – BlackRock Inc is adding bitcoin futures as an eligible investment to two funds, a company filing showed, in a move to bring the world of cryptocurrency to its clients.

The world’s largest asset manager said it could use bitcoin derivatives for its funds BlackRock Strategic Income Opportunities and BlackRock Global Allocation Fund Inc.

The funds will invest only in cash-settled bitcoin futures traded on commodity exchanges registered with the Commodity Futures Trading Commission, the company said in a filing to the Securities and Exchange Commission on Wednesday.

Chief Executive Officer Larry Fink had said at the Council of Foreign Relations in December that bitcoin is seeing big giant moves every day and could possibly evolve into a global market. (https://bit.ly/2XXFHrB)

Earlier this month, Bitcoin, the world’s most popular cryptocurrency, hit a record high of $40,000, rallying more than 900% from a low in March and having only just breached $20,000 in mid-December.

A BlackRock spokesperson declined to comment beyond the filings when contacted by Reuters.

(Reporting by Radhika Anilkumar and Bhargav Acharya in Bengaluru; Editing by Arun Koyyur)

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