What will Mario and the ECB do about Italy now?

02/26/2013 5:12 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

What will Mario Draghi do? The head of the European Central Bank has been notably silent in the aftermath of the Italian election debacle even as other EuroZone financial figures have threatened that Italy must keep its austerity bargain or else. (It’s not quite clear what “or else” might be in the this case. It’s one thing to threaten to kick Greece out of the euro and quite another to threaten a key EuroZone economy and the world’s third largest government bond market.)

Fortunately, Draghi does have some important ammunition left to him for this crisis—if he needs it and if he can get the Germans to agree (before their own key election in the fall.) At its last meeting on February 7, the European Central Bank decided not to cut its benchmark short-term interest rate below the current 0.75% rate.

That gives Draghi and the ECB the option of cutting interest rates by 25 basis points to 0.5%--if the bank wants to send a message of hope and reassurance to all those voters in Italy—and in Spain, Portugal, and France—that are clamoring for some efforts at economic growth instead of nothing but budget cuts, higher taxes, and increased unemployment.

The central bank doesn’t meet again until March 7, which gives Draghi plenty of time to assess exactly how bad things will get in Italy and in the financial markets. The first test of that comes tomorrow when Italy attempts to auction 6.5 billion euros of five-and ten-year notes. The yield on the benchmark ten-year note climbed to 4.91% today from 4.37% as bond buyers demanded higher payments if they were going to take on greater risk. The 5% level is an important marker in tomorrow’s auction—a yield that climbs much above that will increase fears that the Italian bond market could be headed back to the bad old days of November 2011 when the Italian ten-year bond yielded 7.9%.

That was before Draghi promised to do “whatever it takes” to preserve euro. The next few weeks will tell markets what “whatever it takes” will mean after the Italian election.

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