In the wake of fresh sex and bribe scandals of Italian Prime Minister Silvio Berlusconi as well as Italy’s backing down on austerity measures, interest rates are once again creeping back up on Italy.

10-Year Italian Government Bond Yields

Italy Drops Plan to Tax Higher Earners From Austerity Bill

Bloomberg reports Italy Drops Plan to Tax Higher Earners From Austerity Bill

Prime Minister Silvio Berlusconi’s government has dropped a planned bonus tax on Italians earning more than 90,000 euros ($131,000) a year from a package of austerity measures that aims to balance the budget in 2013.

The levy will be replaced with other measures that aim to target tax evaders, Berlusconi’s office said in an e-mailed statement. The decision came after Berlusconi and Finance Minister Giulio Tremonti met with Northern League leader Umberto Bossi, a coalition ally that opposed some of the key aspects of the austerity plan passed by Berlusconi’s Cabinet on Aug. 12.

As a result of today’s agreement, the plan will also be modified to reduce the cuts in transfers to regional and local governments. The note did not give details of how the government would compensate for the lost deficit reduction from today’s changes.

Revenue Replaced in Unknown Way

Allegedly the revenue will be replaced in an unannounced, unknown way. Does anyone believe that?

Bank of Italy Warns Tax Hikes Needed

The Washington Post reports Bank of Italy warns government’s new austerity measures must raise taxes, cut spending

The Bank of Italy warned Tuesday that the government’s revamped austerity plan must not cut back on its original €45.5 billion ($65.9 billion) proposal to raise taxes and cut spending — and said even with the plan Italy risked economic stagnation.

Premier Silvio Berlusconi and his allies late Monday issued a revision of the proposed austerity measures after widespread public anger, deciding to scrap special tax on high earners and spare small town governments. The new measures tinker with retirement age and call for a reduction in the number of lawmakers.

The Bank of Italy’s deputy chief Ignazio Visco told parliament committees Tuesday that he hoped the market’s response to the revision “isn’t too penalizing.” He said the overall austerity measures “cannot be reduced” and will be monitored to ensure they’re being followed.

He warned that regardless of the measures, Italy still risked “a phase” of economic stagnation. Growth might be less than one percent this year and even less in 2012, making aims for a balanced budget more difficult, he warned.

Phase of Recession Not Stagnation

I remain in awe of cental bank ability to tell bald-faced lies. The idea that Italy will grow in 2011 and 2012 in the face of a global recession with additional austerity measures is nonsensical.

German Central Bank Complains EU Treaty “Completely Gutted”

The Telegraph reports EU law “gutted” by bail-outs, growls Bundesbank

Jens Weidmann, the bank’s president, said monetary union risks losing its democratic legitimacy as EU leaders take a “large step” towards a debt union without legal authority, and sever the crucial link between budget policy and elected parliaments.

He said mass bond purchases by the European Central Bank had “strained the existing framework of the currency union and blurred the boundaries between monetary policy and fiscal policy. Decisions on further risk-taking should be made by governments and parliaments, as only they have democratic legitimacy.”

Mr Weidmanm said that if Europe is unwilling to accept a genuine fiscal union backed by a European tax system, it must strengthen the existing ‘no bail-out’ clause in the EU Treaties “instead of letting it be completely gutted.”

The escalating protest from the Bundesbank leaves the ECB in an invidious situation as it tries to shore up Italy and Spain, holding yields on their 10-year bonds at 5pc by intervening on the secondary market.

Julian Callow said Italy must redeem a record €62bn (£55bn) of debt by the end of September yet the government of Silvio Berlusconi is blacksliding on its austerity package and cavilling over details.

“This is a very large sum of money. The situation is extremely serious, and this is no time to be rearranging deck chairs,” Mr Callow said, suggesting that ECB chief Jean-Claude Trichet may have to go to Rome to read the riot act.

Mr Callow said the eurozone is already in an industrial recession and needs stimulus to head off a possible credit crunch and stabilise the debt crisis. He said the ECB should cut interest rates to cushion the effect of fiscal tightening in a string of EMU states and halt accelerating capital flight from the eurozone.

Holger Schmieding from Berenberg Bank said there is a “significant risk” of recession across Europe and the UK but insisted it would be a mistake for the authorites to relax on either the fiscal or monetary front. “They must tough it out,” he said.

Europe’s sharp downturn will make it even harder for Italy and Spain to meet budget targets and grow their way out of debt traps. It may doom Greece’s rescue programme.

Barclays Capital said the Greek economy is in the grip of debt-deflation and is likely to contract a further 5.7pc this year. The deficit remains stuck at 8pc of GDP. The parliament’s own watchdog said debt dynamics are “out of control”.

Riot Act

Julian Callow, Managing Director and Chief European Economist for Barclays Capital suggests

“Trichet to go to Rome to read the riot act.”

There will be a riot act alright, and it will come when the people of Greece, Spain, Italy, and Ireland have had enough of austerity measures aimed at bailing out foreign banks.

Mike “Mish” Shedlock

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