The cost of borrowing for the Italian sovereign rose to its highest since 2014 today amid investor fears of a face-off with the EU over the size of the deficit under the populist government’s spending plans.
The yield on a 10-year sovereign bond, which moves inversely to prices, surged by more than 20 basis points to hit 3.464 per cent, according to Tradeweb. The premium demanded by investors to lend to Italy over Germany – widely perceived as a barometer of political risk – also rose to its highest since June 2013.
The government last week set a budget which will run a deficit of 2.4 per cent of GDP for the next three years, in breach of EU rules according to officials from the European Commission, the EU’s executive body.
Italy is regarded by economists as one of the most vulnerable Eurozone economies to a damaging confrontation with financial markets, with a debt load last recorded at more than 130 per cent of GDP.
The escalating pressure has set up a high-stakes confrontation between Brussels and Rome, with Italian government figures giving no sign of backing down from policies which include a guaranteed minimum income.
Matteo Salvini, the leader of the far-right Northern League, a partner in Italy’s anti-establishment coalition, suggested on Twitter that European Commission president Jean-Claude Juncker was deliberately pushing up Italian borrowing costs to attack the government. Meanwhile, another Northern League politician suggested leaving the euro could help solve Italy’s fiscal issues, before rowing back and saying there is “no plan to leave the euro” in an interview with Bloomberg.
Luigi Di Maio, deputy prime minister and leader of the Five-Star Movement, the other coalition partner, told Italian radio he will “not backtrack by a millimetre" on running a higher deficit, according to Reuters.
The threat of a fiscal crisis has driven a stampede by investors to dump Italian bonds, with Tradeweb last week recording the biggest single-day of euro-denominated bond trading since 2011, the height of the Eurozone crisis.
The euro fell to its lowest against the US dollar since 21 August, briefly touching $1.1505 before recovering to a loss of around a 0.3 per cent at the time of writing.
If Italy does hold its course it would likely face the prospect of a downgrade by major ratings agencies, with Italian government debt currently ranked just above “junk” status. Many large institutional investors are not permitted by their mandates to hold bonds which are not “investment-grade” – potentially adding further to the squeeze on government borrowing costs in the event of a downgrade.
Sandra Holdsworth, head of rates and fixed income at Kames Capital, said: “The implications of the world’s third largest bond market moving to junk are enormous. The flight of capital from Italy would be vast.”
However, Carl Eichstaedt, fixed income portfolio manager at Western Asset, said that he does not expect a crisis of the same magnitude of the Eurozone sovereign debt crisis of 2013 – although yields could rise further in the short term as political wrangling continues.