Italy’s brawl with with Brussels intensified on Monday, triggering a plunge in Italian markets and a broad European selloff that that also sent Asian shares lower.
The Italian populist government’s refusal to bow to the demands of the European Union’s fiscal authorities to reduce the country’s ballooning budget deficit has emerged as the EU’s greatest fiscal concern and has rattled investors across the continent.
Italy is the euro zone’s third largest economy and the fourth-most indebted country in the world, measured by debt to gross domestic product, and the EU fears a new debt crisis could emerge as Italian sovereign bond yields rise and a debt downgrade becomes a distinct possibility by the end of the month.
Benchmark Italian 10-year bonds sold off sharply, pushing their yields to 3.63 per cent on Monday, up from 3.40 per cent on Friday. The yields have been rising relentlessly since the late spring, when the League and the Five Star Movement, the two anti-establishment, euro-skeptic parties that won the March election, formed a coalition government that set out to defy the EU’s rule on budget deficits. Before the election, Italian yields were under 2 per cent.
The spread between Italian bonds and their German equivalents, viewed as the best proxy for the risk premium demanded by investors to own Italian debt, reached 308 basis points, up from 284 basis points on Friday (100 basis points equal one percentage point).
As Italian debt prices sank, so did Italian equities. At one point, Milan’s FTSE MIB index was down more than 2 per cent, taking the one-month loss to more than 5 per cent. Italy’s top banks, which are among the biggest in Europe and loaded with Italian debt, plunged. UniCredit and Intesa Sanpaolo were down as much as 4.2 per cent near the end of the trading day. Germany’s Dax index and London’s FTSE-100 each lost about 1 per cent, as did Hong Kong’s Hang Seng Index.
The EU’s immediate concern is the Italian government’s plan to triple the budget deficit to 2.4 per cent, in a country where the debt to GDP, at 131 per cent, the highest on the continent and second only to Greece’s.
“What we see is worrying,” Klaus Regling, head of the European Stability Mechanism, the euro zone’s financial stability and bailout fund, told Bloomberg Television over the weekend. “The fiscal targets announced by the new government that came into office a few months ago are out of line with the agreed fiscal framework that euro-area countries have given themselves unanimously.”
On Monday, Matteo Salvini, the League leader who is Italy’s deputy prime minister and the public face of the government, ramped up his attacks on the EU.
Sitting next to Marine Le Pen, leader of France’s National Rally party (formerly the National Front) at a labour union congress in Rome, Mr. Salvini blamed Brussels and its austerity regime for damaging Italy and the rest of Europe - a strong hint that his government has no intention of trimming the projected budget deficit as it finalizes the 2019 budget, its first since the spring election.
“We are against the enemies of Europe – [Jean-Claude] Juncker and [Pierre] Moscovici – shut away in the Brussels Bunker,” he said, referring to the European Commission president and EC’s economic affairs commissioner. “The politics of the last few years has increased Italian debt and impoverished Italy.”
Mr. Salvini seems to be winning his showdown with the EU and his rising popularity ratings suggest he has the support of Italian voters. He also apparently knows that Italian bond yields, while rising, are nowhere near the crisis levels of 2011 and 2012, when there was open talk of Italy being forced into a bailout. Disaster was averted in 2012 when European Central Bank president Mario Draghi said he would do “whatever it takes” to save the euro. His firefighting policies sent Italian yields down to safe levels.
While Italian yields are the highest in the EU, bar Greece’s, the country can still borrow at prices that are only slightly higher than those of the United States. At current bond yields, the Italian government seems unlikely to accommodate the EU’s budget demand, all the more so since the coalition pledged to pass a budget that would help the Italian people, not investors.