Italian bank stocks led gains across Europe, with Intesa Saopaolo up around 5% at 7:30 am on news that Italy’s second-largest bank would acquire the performing assets of two failing banks in the country’s Northeast.

The Italian authorities bailed out the senior bondholders (and the failed banks’ senior debt surged 15% this morning in response). That’s good for the banks, who are the recipients of state support, but not necessarily so good for Italy’s enormous sovereign debt. The dog that didn’t bark in this morning’s market was the spread between Italian 10-year government bonds and German government bonds. This has fallen from more than 2 percentage points during the political tremors earlier this year to 1.64%, and it failed to move this morning.

On June 9 we speculated that a fix was in for Italy. Asia Unhedged cheered the momentum in the Italian market, but we remain cautious. The biggest gainer has been the senior credit of Italian banks, which has been ring-fenced by the Italian state. The stock price of the country’s largest (and presumably soundest) bank, Unicredito, jumped today, but still languishes below its May peak. Its credit spread meanwhile has plunged, as the chart shows.

As Franceso Galietti of Policy Sonar observes, the state can bail out the banks, but who will bail out the state?

Galietti writes:

From a political risk point of view, there are two emerging points that warrant scrutiny.

First, how will the public react to the bank bailout, which appears remarkably generous to Italy’s largest lender while costing more than the IVA sales tax hike the government has promised not to trigger? It is Policy Sonar’s view that old-school approaches to buying consensus and peace – no bank failure on my watch, at the very least – will backfire.

Italians may not enthuse over a deal that safeguards bondholders, most of whom are relatively comfortable. Istat recently noted that Italy’s welfare state transfers decrease post-tax income inequality, but that’s almost entirely due to pensions. Italy’s current tax-and-benefit schemes currently increase the risk of poverty for the overwhelming majority of citizens under the age of 34. Assessing whether this cohort will turn out to vote is a dark art everywhere but even if it does there is no evidence to suggest a UK-like surge in support for the main left-leaning party.