Stocks Soar as Italy and Greece Act on Austerity

Despite the fact that George Soros is warning the euro zone debt crisis could be worse than the Lehman Brothers crisis, stocks across Europe rallied Wednesday following news from Athens and Rome on how they plan to tackle their budget deficits.

On Tuesday, Silvio Berlusconi’s government unveiled how it plans to make up the recent concessions on austerity spending it had promised a number of special interest groups.

Italy's value added tax (VAT) will be raised by 1 percentage point to 21 percent. Those earning over 500,000 euros (US$705,000) will be subject to at 3 percent levy, which Reuters reports will raise 35 million euros (US$49 million) next year and 88 million euros (US$123.4 million) a year from 2013.

The measures where welcomed by the European Commission, which said they showed Italy’s determination to meet its fiscal targets and deal with its deeply rooted structural weaknesses.

The commission, though, is not who Berlusconi and his finance minister Giulio Tremonti need to convince.

Following renewed selling of Italian bonds and warnings from both Jean-Claude Trichet and Mario Draghi—the Italian who will replace him as European Central Bank (ECB) boss in November—Tuesday’s measures will go some way to appeasing the central bank, which only agreed to buy Italian bonds in the open market if Berlusconi got spending under control.

We are unlikely to hear much from Trichet or other ECB members until Thursday's press conference following the ECB rate decision in Frankfurt, but Barclays Capital said it welcomed the measures.

“We think the most effective is likely to be the VAT rate increase. Over the past few weeks, media reports suggested that the increase could bring additional annual revenues of four to six billion euros,” Fabio Fois, a European economist at Barclays Capital, said on Wednesday.

Italy’s biggest worker union estimates the VAT hike will only raise 3 billion euros a year.

Wait 130 Days

Fios added: “We view favorably the introduction to the constitution of a 'golden rule' on a balanced budget and the transfer of provincial government functions to the regions. The latter measures, however, will require at minimum of 130 days before being finally approved as they require changes to the constitutional.”

Given the revisions, to the original austerity measures 130 days is a long time for some in the markets.

Italian bond yields have fallen from their early week highs, but remain well above 5 percent on the 10 year note—though Athens would no doubt be delighted with that relatively low cost of borrowing.

If Italy has some work to do to convince the ECB and the bond market of its commitment to austerity, Greece has an even more difficult job.

Two-year yields are trading above 50 percent—a rate you would expect from a loan shark, rather than the international capital markets for a sovereign member of the euro zone.

In a bid to kick-start strained talks with the International Monetary Fund, the European Union, and the ECB, Greece on Tuesday proposed speeding up payments on the money it receives from the second bailout package and speed up privatization plans and structural reforms.

Greek yields hardly reacted to the news but as we prepare for the Bank of England and ECB decisions and President Barack Obama’s eagerly awaited speech on jobs, the market appears a little more relaxed about the euro zone debt crisis, for now at least.