Markets Rattled at Prospect of Italy-EU Budget Clash

A general sense of anxiety is weighing on the financial markets as Italy’s populist government doubles down on its contentious budget proposal, despite clear warnings from the European Commission.

A general sense of anxiety is weighing on the financial markets as Italy’s populist government doubles down on its contentious budget proposal, despite clear warnings from the European Commission. Analysts suffering from a more pessimistic disposition worry that the resultant bad blood may risk destabilising the entire eurozone. FXTM Senior Staff Writer Kirsty MacSween examines the tensions informing the Italian national budget and its potential impact at home and abroad.

The context: costly election promises

After a grueling, inconclusive Italian election in March, the two largest parties eventually cobbled together a controversial coalition government that struggled to win final approval. Disillusionment with centrist politics and the creeping rise of nationalistic fervor across Europe had pushed voters towards two (formerly) fringe parties – anti-establishment Five Star and the far-right League. The ensuing chaos rocked the Italian bond market and raised concerns about a possible Italian exit from the EU.

Aside from general Eurosceptic rhetoric, part of both parties’ appeal lay in the economic promises they made on the campaign trail – promises that are now proving expensive to factor into the national budget plans. Both parties said they would prioritize the Italian people over international concerns. The rise of nationalist parties espousing protectionist sentiments like these in Europe is adding to tension across the political and economic superstate, putting pressure on the values of collaboration and mutual support on which the union rests. The League proposed slashing taxes to return economic power to the Italian individual, while Five Star campaigned on the promise of introducing a guaranteed income for the unemployed and improving the pension provisions so that workers could retire earlier.

Debt & deficit: Proposed budget raises questions

Ahead of the October 15 deadline for submitting a national budget to the EU, Italy’s cabinet approved a budget plan in late September that increased public spending and allowed for a deficit of 2.4% of GDP (gross domestic product) for the next three years. This commitment to public spending is at odds with the former administration’s promise to the European Commission that they would rein in the country’s deficit and not breach 0.8% in 2019. With the second-largest sovereign debt of any member of the eurozone (130% of its GDP), Brussels expects Italy’s new government to follow the example of its predecessor and attempt to trim back instead of accelerating spending. According to EU fiscal rules, a country with a debt of over 60% of GDP must implement measures to shrink its debt pile.

The Italian cabinet, however, seems determined to loosen the budget to allow for the funding of the anti-austerity policies that proved popular during the electoral race. €10 billion is ringfenced in the proposed budget to provide a citizens’ income (a kind of universal income), while the pension pot is expanded to allow for a lower retirement age. The Five Star-League coalition’s position is that these measures along with tax cuts will help stimulate the Italian economy and raise employment.

Tensions rise: EU fights back

The reaction from Brussels has been muted but less than impressed. European Commission President Jean-Claude Juncker warned against repeating the mistakes of the Greek crisis, but stressed that they would wait until the budget was submitted officially before further comment or analysis. Sources suggest that the European Commission may go so far as to reject Italy’s budget as it stands, a move that is unprecedented throughout the union’s 60-year history.

However, Italy’s administration is emphatically not open to compromise. Bellicose rhetoric from the League’s leader and Deputy Prime Minister Matteo Salvini is inflaming existing tensions and doing little to quell the disquieting sense that Italy’s leaders might edge closer to pursuing an exit from the euro altogether (despite assurances to the contrary). Speaking in Rome at a press conference with his French far-right counterpart Marine Le Pen, Salvini denounced Juncker and other EU Commission figures as the true enemies of Europe. This combative stance is echoed by Five Star’s Luigi Di Maio (Italy’s other deputy prime minister), who commented that he would defend the Italian people rather than concede to market pressures if that’s what it came down to.

Fallout: Financial markets react

Market pressures may prove too overwhelming to be ignored – even before an official response from Brussels forces a revised budget. Yields on Italian bonds have spiked, surging to their highest levels in four years, while Italian stocks plummeted overnight by 2%, as unsettled investors recoiled from Italian assets and instruments contaminated by the clash. Investors are spooked by the budget’s comfortable attitude to increased debt, and the likelihood that public expenditure won’t be put into the necessary infrastructural improvements that could help galvanize the sluggish Italian economy.

Uninspiring fundamentals may be driving investors away from Italian assets in particular but this latest outbreak of anti-euro defiance is also putting pressure on the single currency in general, which is already embattled by dollar strength and global trade war fears. On October 9, the euro dropped 0.4% against the dollar to $1.1444, its lowest value since August 20. If the relationship between the EU and Italy’s government deteriorates any further, it’s probable that we’ll see further turbulence for the euro. The deadline for Italy’s submission of their national budget is October 15; the forex market might, in all likelihood, be sensitive to any movements that suggest further upheaval in the eurozone over the coming weeks.

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