EU deems Italian budget 'unacceptable', bond yields spring higher

The European Commission sent a letter to Rome on Thursday, querying authorities about the assumptions for economic growth underlying their budget proposals.

Brussels reportedly also asked the new government in Italy to explain why it had veered from its commitments to maintain a tight fiscal policy.

Officials in Rome were not alone, with the EC having reportedly also sent letter to Belgium, France, Portugal, Slovenia and Spain.

Nevertheless, the Commission's letter left scant room for doubts, stating that the 2019 Italian budget bill was "without precedent in the history of the Stability Pact" leading to "a particularly serious non-compliance with the Pact's obligations."

Having met with Italian Economy Minister in Rome, Giovanni Tria, EC Economic Affairs Commissioner, Pierre Moscovici, said the Mediterranean country's budget deficit could not be set at 2.4% of gross domestic product, ANSA reported.

"That is impossible," Moscovi said, going on to explain that other EU countries had expressed concerns about Rome's plans.

In response, as of 1935 BST the yield on the benchmark 10-year Italian Treasury note was 14 basis points higher at 3.69%, alongside a four basis point drop on similarly-dated German bunds to 0.42%.

Hence, the 'spread' between the two yields, one closely-followed measure of Italy's risk premium was at 327 basis points - its highest since February 2014.

IT DOESN'T REALLY MATTER?

The deadline for Rome to reply was set for noon on 23 October, with the EC expected to request, by 29 October at the latest, that Rome go back to the drawing board, even as some of the latest reports pointed to friction between the parties making up the coalition government, the Five Star Movement and League.

Under a worst case scenario, Brussels might eventually be forced into sanctioning Italy for flouting the bloc's budget rules, although Jack Allen at Capital Economics believed that was unlikely.

Instead, the EU would "do everything in its power to avoid sanctions, which could risk fanning eurosceptic flames in Italy."

Then again, whether or not Brussels did finally do so did not really matter, he said.

"But either way, Italy’s economic and fiscal outlook is grim, so we expect bond yields to keep rising."