December 19, 2018 / 12:29 PM / a month ago

Breakingviews - Italy’s budget truce may yet herald 2019 hangover

Italy's Prime Minister-designate Giuseppe Conte leaves after a meeting with the Italian President Sergio Mattarella at the Quirinal Palace in Rome, Italy, May 27, 2018. REUTERS/Alessandro Bianchi - RC12725CED60

MILAN (Reuters Breakingviews) - Italy’s anti-austerity leaders have backed down – a bit. Rome on Wednesday agreed a workaround on its budget deficit goals to end a damaging row with the European Commission. It brings welcome respite to Italian assets, but new challenges risk overshadowing the truce.

Prime Minister Giuseppe Conte has agreed to lower the country’s 2019 deficit target to 2.04 percent of GDP, down from 2.4 percent. This is a U-turn from initial government pledges not to give in to EU requests. But the concessions could be cosmetic. An estimated 4 billion euros of savings from questionable welfare handouts will be achieved by delaying implementation and tinkering at the edges. Italy has also promised to raise 2 billion euros from one-off measures such as asset sales, Il Sole 24 Ore reported on December 19.

The agreement, due to be formally announced on Wednesday, spares Italy from the risk of EU fines. The relief sent two-year government bond yields to their lowest since the end of May, when a coalition between the far-right League and the anti-establishment 5-Star Movement was formed. Local bank shares also rallied.

Although welcome, the deal does not address some imminent challenges. Italy will need to refinance nearly 90 billion euros of government debt in the first quarter of next year, half of which is long-term BTPs. This may prove more difficult now the European Central Bank has formally ended its 2.6 trillion euro bond purchasing scheme that Mario Draghi launched to fight the euro zone crisis. The end of the programme means the central bank will no longer be a net buyer of Italian state bonds.

Rome may need to lure back foreign investors who have fled Italian government debt to the tune of 70 billon between the end of May and September. The timing is, however, not great. Italy’s economy contracted for the first time since 2014 in the three months to September and could weaken again this quarter, creating a new recession. The government has implicitly admitted that things are not going well by cutting growth forecasts for next year to 1 percent of GDP from 1.5 percent. With Italy’s budget lacking substantial growth-enhancing measures, even that seems optimistic.

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