News of the week summary - 08/13/2023

Italy shocks market by announcing a tax on banks' windfall profits

In a surprise move, Italy has introduced a new tax on windfall profits earned by banks. The tax was announced by Deputy Prime Minister Matteo Salvini and has sent shockwaves through the financial markets. It will apply a 40% levy on the extra profits made by lenders, particularly targeting their higher interest incomes following recent rate hikes by the European Central Bank. This tax aims to fund measures to alleviate financial pressure on families and companies and requires approval by the parliament.

• Net interest income: the difference between the interest earned by a financial institutio, from its interest-earning assets (like loans and investments) and the interest paid on its interest-bearing liabilities (such as deposits and borrowings).

The nation's largest banks, Intesa Sanpaolo and UniCredit, which have seen substantial net interest income increases, are expected to bear the brunt of this tax. While the government did not specify the exact measure for the tax cap, it could reach up to 0.1% of a bank's assets. If calculated based on global assets, this would mean the two major banks could face levies of around $1 billion each.

Investors and experts have raised concerns about the motivations of Italian economic policy, which may lead to questions about the credit risk of Italian banks compared to German banks. The move has led to sharp declines in Italian bank stocks and triggered discussions about the impact on the banks' capital, profits, and cost of equity.

This tax on windfall profits is part of Italy's populist administration's attempt to finance assistance for families dealing with the cost-of-living crisis, which includes tax cuts and mortgage support for first-time homeowners. However, this measure could face challenges in the parliament and possibly the courts, similar to a windfall tax introduced in Spain.

Several European countries, including the UK, Spain, Lithuania, Estonia, and Latvia, have contemplated or implemented similar measures to tax banks' profits following interest rate hikes. This reveals a growing global trend of addressing banks' windfall profits to fund public measures and reduce inflationary pressures.

US Job market displays strong growth again

The US job market displayed solid growth in July, with an increase of 187,000 non-farm payrolls (number of workers except those in farming, private households, proprietors, non-profit employees, and active military). 

This figure is slightly lower than expectations but continues the momentum from June, reflecting sustained labor demand. The unemployment rate unexpectedly fell to 3.5%, reaching one of the lowest levels in decades, while average hourly earnings saw a firm 0.4% increase from June and a 4.4% rise from a year earlier, exceeding forecasts.

These positive job and income gains indicate that the US economy can withstand rapid interest rate increases aimed at controlling high inflation. The Federal Reserve (the American central bank) aims for a "soft landing," and experts believe that the current payroll growth, not too hot or cold, aligns with this objective.

While wage growth has been strong, there are signs that it may slow as the supply and demand for workers become more balanced, following labor shortages induced by the pandemic. Employment growth was particularly notable in service providers, healthcare, financial activities, and construction sectors. These figures, combined with slower inflation, support the idea that the Federal Reserve can combat inflation without causing a recession. The Federal Reserve has already resumed raising interest rates and may continue to do so based on incoming data.

The report also highlights that the imbalance in the labor market is gradually easing, but challenges remain. The overall participation rate remains high, but the rate for those ages 25-54 declined due to women leaving the labor force. Treasury yields dropped, and the S&P 500 saw gains, with traders reducing their expectation of further Fed rate hikes this year.