Yields on debt for the two countries are converging, thanks to instability in Paris and a Rome government that has managed to divide the opposition.
ROME — At any other time in recent history, the Italian government may have been tempted to use the budget chaos in France as a pretext to let its own discipline slip. But Prime Minister Giorgia Meloni hasn’t succumbed — and financial markets are rewarding her government as a result.
Throughout the past month, Meloni’s plans to bring Italy’s budget deficit down have prompted occasionally violent nationwide strikes, outcry from businesses and repeated rounds of bitter parliamentary infighting. Yet Italy’s borrowing costs, a key gauge of market confidence in the country, have fallen to their lowest level in more than two years, both in absolute terms and relative to its peers.
Like France, Italy is under strict orders from Brussels to rein in a ballooning deficit that hit 7.4 percent of GDP in 2023. The difference is that Meloni commands a stable majority in parliament that has allowed her to resist most calls to increase spending. In October, her government outlined plans to bring down the deficit somewhat faster than expected, winning EU approval. Factional requests for concessions around the final budget law now concern relatively small sums.
Ken Egan of credit agency KBRA notes that Meloni’s greater control over her government gives her the space to push through a cost-cutting agenda. But she has also benefited from deep divisions in the parliamentary opposition and the labor movement that have hamstrung efforts to mobilize against her.
On the political front, for instance, junior coalition partners extracted only small concessions while the center left has struggled to put forward a united front, bickering most recently over the proposed implementation of a sugar tax. Despite recent wins for the opposition Democratic Party last month in regional elections in Umbria and Emilia-Romagna, Meloni’s grip remains relatively firm.
A series of recent strikes across the country, meanwhile, were short-lived and ineffectual — in part thanks to fierce disagreement among the unions, according to Luigino Boscaro, the secretary of Venetian tourism trade group Italian Union of Tourism, Commerce and Service Workers. He added that the government itself had exploited the divisions, “bringing myriad smaller and unrepresentative unions to the table.” The Italian finance ministry did not immediately respond to a request for comment.
“There’s a sense of resignation — that, strike or no strike, the government will do what it wants,” added Guido Quici, president of the Cimo union which led a doctors’ strike last month.
The markets, at least, have signaled their approval, with the spread between Italy’s 10-year government bond yield and that of Germany has fallen to a mere 1.09 percentage point — the smallest gap since October 2021.
Strength in Italy
The comparison with French borrowing costs is instructive. A combination of budgetary and political factors have hammered investors’ perception of France’s fiscal position. While Paris used to be considered a roughly equivalent credit to Berlin, the French 10-year rate has steadily drifted away from its German anchor. Last week, as the clock ran down on Prime Minister Michel Barnier’s government, it was level with Greece. Now a new humiliation may await France: parity with Italy.
“There is a fundamental reassessment” in progress, said Guillermo Felices, global investment strategist at PGIM Fixed Income.
In Egan’s view, some of Italy’s underappreciated fundamentals — such as its resilience to energy shocks, its low corporate and household debt, and its highly liquid bond market — are being reflected to a greater extent, even if expectations of growth remain low.
“There’s probably more strength in Italy than the market sometimes gives credit for, and maybe some of these factors are being reflected in the narrowing spread between the two sovereigns,” he said.
Indeed, with the exception of the pandemic, Italy has consistently been spending less money than it earns in taxes, when excluding interest payments — a situation known as a primary surplus. The government has forecast it will reach another primary surplus again this year; the opposite has been true in France.
As Oxford Economics’ Daniel Kral pointed out, the performance of Italy’s bonds is impressive because it has happened at a time when the European Central Bank is rapidly running down its portfolio of eurozone government bonds. The ECB’s bond purchases had disproportionately favored Italy for most of the last decade, and their unwinding should logically have had the reverse effect.
For now, the market has reached an uneasy equilibrium: While France’s risk premium has increased in recent weeks, it hasn’t spiraled out of control since the government’s collapse, as Barnier and his ministers threatened it would.
The market “seems to be relieved” that French President Emmanuel Macron has shelved the idea of resigning, said Radoslav Radev, head of fixed income at UBS La Maison de Gestion.
But, he added: “France, politically speaking, is still not out of the woods.”