Italy: Environment will tend to keep volatility in bond yields elevated - ING

Paolo Pizzoli, Senior Economist at ING, points out that developments signal little willingness to substantially amend the budget draft regarding Italy’s saga.  He sees a risk of a continuation of a challenging attitude by the government.

Key Quotes: 

“Late on Friday, Moody’s announced that it had downgraded Italy to Baa3 (from Baa2), switching to a neutral outlook.”

“Next Friday, S&P will release its update to the Italian sovereign rating, currently at BBB with a neutral outlook. Moody’s decision to some extent has stolen the thunder from S&P, which is at least expected to change its outlook to negative.”

“The content of Tria’s reply letter does not legitimize the strong optimism on the government's willingness to revise the budget draft.”

“On the back of the budget draft and of the letter which re-affirmed its validity, the EU Commission will have to formally reply by the end of the month. We expect the Commission to ask the Italian government to submit a revised draft. Barring a substantial acceleration of market pressure on Italian bonds, we would expect the Government to be willing to concede only limited amendments to the current text, possibly in the direction of a commitment to resume the structural adjustment already in 2020 and not in 2022. This would probably be not enough to stop the Commission from re-opening an excessive deficit procedure against Italy, more likely in 2019.”

“With the 2019 European elections looming, the risk is that the Italian government will maintain a challenging attitude towards Europe over the next few months, without pushing the relationship to the extreme. This is an environment that will tend to keep volatility in the Italian government bond market elevated.”