30 May 2018
Bob Cunneen, Senior Economist and Portfolio Specialist
Italy's bond and budget gap to Germany
Sources: Sources: NAB Asset Management Services Limited, IMF Fiscal Monitor, Thomson Reuters.
Italy is again in the headlights. After the European debt crisis of 2011-12, Italy managed to enter a brief period of stability. However in Italian history, stability is only temporary.
Italy’s budget deficit had gradually improved to -2 % of nominal GDP in 2017. Yet this was still well above their more conservative German partners who are running a 1% budget surplus. Indeed this 3% budget balance gap between Italy and Germany (inverted red line) had been stable over recent years.
The European Central Bank’s (ECB) “whatever it takes” bond purchases and low interest rates helped push Italian government bond yields down over recent years. Italian bond investors now seem to have been lulled into a sense of complacency by the ECB policy actions over the past five years and wishfully ignored Italy’s potential risks.
After Italy’s confusing general election in March 2018, a strange coalition involving the conservative Northern League and the populist Five Star Movement agreed to form government in May. This new coalition pledged to provide income tax cuts and to increase pension and welfare benefits.
Bond investors have now become alarmed about Italy’s budget discipline prospects. Italian government bond yields have surged higher over recent weeks .The yield spread between Italy’s 10 year government bond and the German government bond has widened to 2.9% (blue line) which is the largest spread since 2013.
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