A deal has been reached by the full government on 2.4% [of GDP]. We are satisfied. It’s the budget for change.
That’s a quote from a joint statement issued by League leader Matteo Salvini and Five Star chief Luigi Di Maio and it’s characteristically misleading.
Italian assets came under pressure on Thursday when Salvini and Di Maio made a last minute push for a more expansionary budget over the objections of Finance Minister Giovanni Tria, who attempted to draw a line in the sand at 1.9%.
As you can see from the quote here at the outset, Tria lost the battle.
This was predictable. The appeal of populism lies in the promise of short-term fixes for complex problems and in Italy (as in the U.S.) delivering on that promise entails reckless fiscal policy.
It matters not to Salvini and Di Maio whether Italy is on a sustainable fiscal path. All that matters is making good on unrealistic promises to disaffected voters whose fears and prejudices were exploited by populism for political gain.
Over the past several weeks, the market appeared willing to give Italy’s new government the benefit of the doubt on the budget despite frequent reminders from the populists that they are fully prepared (and perhaps even excited about) a showdown with Brussels.
Italy may think they can simply blackmail the E.U. by effectively raising the specter of a financial crisis in an effort to secure some manner of implicit or explicit guarantee from the ECB. Late last month, rumors began to swirl that Italy would ask the central bank for a BTP-specific extension of QE in order to ensure the wind down of ECB asset purchases didn’t exacerbate pressure on Italian bonds.
If that sounds absurd to you, that’s because it is.
Italy’s populists want to flout E.U. budget rules while simultaneously demanding that the ECB print euros in order to prevent the market from punishing the country’s leaders for fiscal profligacy. In other words, Italy’s new government wants to flip the E.U. the bird with one hand and beg for a handout with the other.
Italy’s leaders are acutely aware of the possibility that the bond market will attempt to price in the looser-than-expected budget target. Time and again, Salvini has described rising bond yields as a conspiracy aimed at undermining the populist coalition of which he is a part. In reality, the ECB is the only net buyer of BTPs, which means there is in fact a conspiracy, but it’s aimed not at undermining Italy, but in fact at artificially supporting Italian bonds.
The budget deficit target announced Thursday by Salvini and Di Maio is likely to pressure Italian assets, at least in the short-term.
“If the Stability Programme sets the government deficit-to-GDP ratio at 2.4% in 2019, the 2019 budget law that the Parliament will be asked to approve in coming months will likely lead to an even higher government deficit”, Goldman wrote, after the deficit target was announced, adding that “in 2019, the government deficit-to-GDP ratio will be just short of the 3% Maastricht level, the primary surplus will decline significantly and public debt will be on a rising trajectory again.”
BNP isn’t amused either. “More than the numbers, what matters is the signaling effect”, the bank wrote, in a brief flash note out Thursday afternoon. Here’s a bit more:
We see this as a defeat for Mr Tria, as a guarantor of fiscal prudence, and a victory for the more aggressive line pursued by the coalition parties, the Five Star Movement (M5S) and the League.
The message is clear, in our view: the government’s priority is the (albeit gradual) implementation of its programme, and this overshadows any concerns about the reaction of either the markets or Italy’s EU partners. We do not think either of them will appreciate the fiscal plan.
We couldn’t have said it better ourselves.