Italian stocks and bonds sold off over budget fracas
Italian stocks tumbled and Italian government bond yields surged to new four-year highs after the European Commission expressed concerns over the coalition's draft budgetary plan.
The Commission on Thursday sent a letter to Italy's government to say the country’s draft budget, which deviates by around 1.5% of GDP from the European Union's agreed general government deficit target, has “no precedent in the history" of the EU's stability and growth pact.
The Italian 10-year yield pushed up to 3.75% on Friday, while the 7-year yield is approaching 3.5%, a five year high.
Stocks tumbled too, with the FTSE MIB index down 1.6% to 18,784.70, with banks in particular coming under pressure. Banco BPM and UniCredit were down around 5%.
While the budget rebuttal from the EU was "relatively predictable", said Joshua Mahony, market analyst at IG, it still sparked a surge in treasury yields.
"The problem is that there seems to be no impending resolution between the two sides, with the coalition feeling that they only answer to the electorate, while the EU is unwilling to budge at the risk of setting a bad precedent for the other nations," Mahony said. "The fact that we have seen Italian borrowing costs rise to the highest level in over four-years does little to benefit a government that wishes to ramp up borrowing in a nation with the second highest debt-to-GDP ratio in the EU."
While the situation so far has evolved in line with expectations, Barclays warned that the risks of an earlier EC move have increased, expecting the EC to ask the government to make the necessary amendments to the draft budget to comply with the EU pact.
"However, the general tone of the letter sent by the EC sounds tougher than what we had anticipated. This suggests that the EC may be inclined to recommend opening an Excessive Deficit Procedure earlier (by 30 November) than we expected (spring 2019), possibly because it may consider the current budget season as the last politically feasible window for action before next year’s European Parliament elections in May."
While a rejection of the budget should have largely been priced by markets, Barclays said, "the eventual opening of an EDP could further unsettle sentiment" and that the extent of the effect on the markets "will depend largely on the rhetoric that Italy decides to use in response to a potential decision to open an EDP" and "we do not rule out that the verbal confrontation could escalate".
Credit agencies S&P and Moody's are due to update their Italian credit ratings later this month and the market consensus its that that both will downgrade Italy by one notch.