Italy Considering Leaving The EU?

25th June 2019 Off By binary

By Orbex

On Friday, peripheral bond yields in Europe took a turn for the worse (that is, they rose).

This came after several prominent analysts pointed to private rhetoric by officials in Rome to say “arrivederci” to the EU.

This isn’t a new development. Italy’s relationship with Brussels is, at best, strained. And given the more nationalist and populous sentiment of the government, a potential ‘Italeave’ is something they at least like talking about.

But, how serious is it? The short answer is not much. But that doesn’t mean it can’t drive markets and move risk profiles that have impacts on the exchange rate.

After all, most people said that Britain seriously wouldn’t leave the EU, either. So, even though there is a really broad consensus that deputy PM Salvini is talking tough to appease his popular support more than anything, many investors are quietly hedging their bets. Hence, the move in the Italian yields.

What’s to be Gained?

The central contention between Brussels and Rome right now is the budget for next year. Specifically how much deficit spending the Italian government is “allowed”. Northern Europe tends to be quite strict when it comes to maintaining a budgetary surplus (known as a “fiscal rule”). Italy has a long history of deficit spending. And they adjust to it by debasing their currency.

The situation makes Italy extra uncomfortable in the euro. There are some substantial arguments for Italy to have its own currency. However, the issue at hand is next year’s budget, in which Italy plans to spend more than the EU’s target. But Italy is not alone, and this is causing extra friction.

Why Just Italy?

France, now the second largest economy in the EU, has an even bigger budget deficit. And it’s largely not being criticized for it as much as Italy.

Salvini has argued that this is unfair. He claims that several other countries in the euro area have budget deficits higher than Italy, yet the third largest economy is the only one being singled out. That being said, Italy is also the only country openly defying the rule.

The EU elections gave something of a boost to the Italian position. With Macron fighting strong popular unrest and losing substantially in the polls, there was a sign that the fiscal rule was unpopular.

The election results saw an erosion of the traditional parties across Europe in favor of populists. Even so, the EU continued to talk tough about Italy, saying that discussion of sanctions for Italy’s budget would happen the first week of July.

Is it Working?

Over the weekend, the London-based Financial Times reported that the EU would hold off on launching disciplinary action against Italy over the budget issue.

How long would that “hold off” last? Well, that’s uncertain, since transparency about the budget dispute hasn’t been a thing.

Given the worsening global situation, and Italy flirting with another technical recession (average GDP growth for the last five quarters has been 0), there is an increasing consensus that European action against Italy would only make the entire situation worse.

According to PM Conte, the EU’s sanctions (called EU Deficit Procedure, or EDP) would include €2.0B in spending cuts. That would likely impede growth in Italy, pushing it back into technical recession or worse. It would also generally inflame the potential populist backlash from the third largest voting block in the EU.

And the Markets?

The markets hate uncertainty. And without a clear resolution to the Rome-Brussels dispute, investors are likely to take a risk-off approach. This means higher yields for Italian debt, also making the budget situation for the country worse. Some relief can come from an ECB rate cut, which might help lower debt service costs for Italy and bring their budget closer to the EU target.

Should the EU confirm that no action will be taken, this likely would be seen as a short term relief by the market ending that particular uncertainty. But, then we have the next problem that it might encourage other EU countries in arrears to also defy Brussels, and have a negative effect in the long term. Either way, keep an eye on peripheral yields to gauge risk sentiment.

By Orbex

 

Read more and Click Here To Get Started