Don't expect an immediate impact of market pressure on Italian policymakers

Chart of the week

How likely is it that the Italian government will back down in its ongoing budget negotiations with the European Commission?

It has been a tumultuous week in Italian bond and equity markets. Many investors are hoping that market pressure will swiftly act as a disciplining device in the ongoing budget negotiations between the populist government in Rome and the European Commission . As recently explained, we are a touch more skeptical (see CIO Flash - Italian takeaways ).

The recent selloff raises two interesting questions, however. How much pressure has already been applied? And how might market tensions so far influence policy makers? The answer to the first question is fairly straight-forward. As our "Chart of the week" shows, Italian equities and sovereign bonds have already lost more than 50 billion euros in value over the past five trading days. By contrast, the additional public spending now envisioned for 2019 amounts to 10 billion euros, not a very smart trade for Italian households, you might think.

So, might recent market weakness swiftly prompt Italy's government to reverse its spending plans? Looking a little deeper, there are reasons to doubt that. The bulk of the decline was in bonds, rather than equities. As we previously showed, (see Cotw 9/7/18 ) the share of Italian government debt held by domestic private households and non-financial companies has been shrinking for years. That limits the immediate impact of widening spreads between Italian government bonds compared to their German counterparts.

Nor are there are all that many signs that recent lobbying by business leaders has been effective. Partly that may be because even the right-wing and nominally pro-business Lega is mainly concerned with "Italy’s smallest business owners who produce and sell in Italy. They are all with us.", as Claudio Borghi, the powerful head of Italy's parliamentary budget committee recently told the Financial Times.[1] "People are not really bothered by the spread. The spread is a problem constructed by the media.", Mr. Borghi[2] continued. Investors in Italy and elsewhere should take note.

Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 10/4/18

* Equities: MSCI Italy Index , sovereign bonds: BofA Merrill Lynch Italy Government Index

1. Financial Times, Oct. 10, 2018, Italy’s defiance over deficit alarms business backers. https://www.ft.com/content/dbee1c44-c6fb-11e8-ba8f-ee390057b8c9

2. Mr. Borghi used to work in equity sales, including at Deutsche Bank.

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