Italian bonds: Giorgia Meloni’s moves may yet scare investors

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Italian government bonds are in the middle of an unexpected charmed period. This is despite the country’s heavy ballast of debt, which in July rose to €2.86tn, according to data released by the Bank of Italy on Friday.

There are good reasons for nerves. The economy is slowing. Second-quarter GDP decreased 0.4 per cent sequentially. As a result, the European Commission has cut its 2024 growth forecasts to less than 1 per cent, compared with the 1.5 per cent Italy is hoping for. Worse, the country is struggling to make progress spending part of the €191bn it was awarded by the EU’s recovery and resilience fund, and thus may miss out on a chunk of the money.

Lower growth means less money in government coffers. Fiscal revenues will also be hit by a generous tax credit on construction. That is a problem given Prime Minister Giorgia Meloni’s coalition has already begun the ritual squabble over the country’s budget. Ruling parties are keen to hand out tax cuts to bolster support. With little cash to go around, the fear is that Italy will end up with a higher than expected deficit. 

Yet Italy’s benchmark 10-year bond yield is still 4.39 per cent — only 171 basis points above the German equivalent. That spread has narrowed by almost a fifth since the start of the year, despite Italy’s huge debt load at 144 per cent of gross domestic product. 

Support from the European Central Bank, which indicated it would shield weaker countries facing widening spreads, will have helped. Bond investors may also hope that Meloni will impose discipline on her coalition partners. But she has shown herself willing to rattle markets. Take this summer’s windfall tax on banks, a misguided policy botched in its implementation that drew the ire of international investors.

There are still some buyers for Italian debt, notably individual investors whose cash languishes in low-interest bank accounts. But given the long-term concerns, yields will probably rise.