Italy remains true to itself

Uncertainty about (fiscal) policy developments in Italy has returned. The risk premium on ten-year government bonds over Bunds has risen to a new high for the year. However, a massive sell-off of Italian bonds, as last seen last spring, has so far failed to materialise.

The most recent uncertainty was triggered – as has often been the case – by statements made by Interior Minister Sergio Salvini. The head of Lega has once again criticised EU fiscal rules, and failed to rule out a deficit of more than 3% of GDP for Italy and an increase in its total debt towards 140% of GDP. Salvini also said at an election campaign event that the state should take all necessary fiscal measures until Italy’s unemployment rate halved to 5%.

Until now, the general hope has been that a possible rift within the governing coalition in Rome would exert a beneficial effect on Italy’s budget position. The „weird“ logic involved here runs as follows: a purely right-wing populist alliance that – according to surveys conducted about early parliamentary elections – would enjoy prospects of commanding a majority would be more likely to adhere to the deficit rules than the current pan-populist alliance, where Lega and M5S outdo each other with the gifts they offer to the electorate.

However, Salvini’s recent comments have cast doubt on this assumption. His comments should nonetheless also be seen in the light of the European election campaign, which is now entering a heated phase. In order to achieve the best possible result, he is tempted to make attractive promises to his followers, deploying the usual populist rhetoric. However, we do not expect all of Salvini’s proposals and statements to become government policy.

All in all, it is becoming increasingly clear that expectations of greater fiscal discipline in Italy are likely to be disappointed. It is simply too attractive for Salvini and his comrades-in-arms not to adhere to binding budget rules. Moreover, a growing likelihood exists that Italy could actually succeed with this type of policy, as the European mainstream is moving in this direction. In other words, political risk in relation to Italy continues to exist. A complete sell-off and a massive rise in yields on Italian government bonds is also not very likely for the time being. Investor confidence in European solidarity would have to be shaken noticeably and lastingly for this to happen.

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