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Recent discussions regarding looser fiscal policy in Italy have exacerbated volatility in the bond market, leading to an increase in the yields of Italian government bonds and to a moderate widening of their spreads. While we do not expect this to translate into an acute sell-off in the near term, in this CIO Special we take a closer look at the underlying dynamics to assess the longer-term risks that may arise.

Here are some of our key takeaways from the recent activity: 

  • Lately, spreads on Italian 10-year bonds have risen above 200 bps, mainly due to the Italian government's higher deficit and lower growth forecasts, as the political tug-of-war over the EU fiscal rules to be reinstated in 2024 enters its final and decisive phase.
  • The Recovery and Resilience Facility (RRF) funds should provide a strong incentive for the Italian government to engage constructively with the EU.
  • Although not our base case at present, the ECB has more scope than in the past to put a cap on bond yields in the event of a significant widening of BTP spreads (via PEPP and TPI).

 

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