Italian bonds bounce as government shifts budget deficit plans
Italian assets rebounded on Wednesday after the government announced its plans to reduce the national budget deficit from 2020 onwards.
This last announcement changes the fiscal path it had traced last week, when the Italy’s finance minister said the government was planning to keep the budget at 2.4% for the next three years.
Italy’s 10-year BTP government bond yield went down by 5 basis points at 3.378% after closing at 3.44% on Tuesday.
In May, original government budget plans suggested an eye-watering deficit of more than 6% of GDP, three times higher than the proposed budget of 2.4% and below the 3% Maastricht limit too.
Italy’s economy minister Giovanni Tria stated few days after the announcement that despite the government’s plans to increase public spending, it would still manage to reduce public debt and to keep a growth path in the country’s GDP over the next two years.
However, the statement was not enough to reassure bond markets fears, with short-dated bond yields rising more than 15 basis points on the 1 of October (four days after the announcement), while five-year Italian debt insurance costs hit their highest level in a month.
Some industry commentators suggested that the European Union would consider unlikely that Italy’s fiscal measures would be able to raise growth to 1.6% and 1.7% in 2019 and 2020 respectively, as projected.
Italy’s public debt level remains above 130% of GDP, which makes the bond market particularly vulnerable to any signs of fiscal “blunder”.
In the immediate aftermath of Italy’s budget announcement, – which led to weakness in Italian assets on fears that this would put Italy on a collision course with the EU – the yield spread between 10-year Italian and German bonds rose to their highest level in a month.
BlueBay AM co-head of Developed Markets Mark Dowding, said: “Policy makers from La Lega and the Five Star parties agreed on a budget deficit target of 2.4% for 2019 and subsequent years, which was higher than the target that Finance Minister Tria had been pushing for. This led to weakness in Italian assets and it is likely that the EU Commission will push back on the plans later in October.”
“Nevertheless, Italy will continue to maintain a healthy fiscal primary surplus under these plans and although the debt/GDP ratio will not decline as Brussels would like, it seems unlikely to rise either – though ultimately progress on this will probably be more dependent on the growth outcome than the fiscal delivery.”
Dowding also explained how assessing BTPs value means assessing the probability of an Italexit from the euro, which he sees with a lack of any substantial support from the public nor the political parties in Italy. “We had hoped that following the Italian budget that Italian 10-year spreads would move inside 200bps and although this seems much less likely to be the case, a sustained move wider from current levels would also seem unjustified with a steep yield curve making it an expensive short to maintain.”
Adrian Hilton, fixed income fund manager at Columbia Threadneedle Investments, commented: “There’s still time to redraft a more conservative budget before it is submitted to the European Council next month, and our baseline is that the present government will stop short of flirting with leaving the eurozone. But this kind of volatility is unhelpful for risk sentiment around Italy, and there remains a risk that ratings downgrades could exacerbate the crisis further. We’re content to maintain a neutral position for now.
“The medium-term fiscal outlook is likely to be looser and the sustainability of its high debt will be harder to achieve as a result. Our chief concern at present is the worsening economic backdrop as both domestic sentiment and international demand wane: the real risk to Italy may materialise later when, without sufficient structural buffers to lower growth rates, the size of primary surplus required to stabilise the debt ratio may become unachievable.”