The Italian coalition government agreed a new national budget last night, after weeks of negotiations between the ruling parties. The deal sets a limit of 2.4% GDP for Italy’s deficit as the new national leadership seeks to meet their election promises by increasing public spending.

The tweet above comes from the account of Italy’s Deputy Prime Minister, Luigi Di Maio, who is also the leader of the Five Star Movement. His message reads “tomorrow we’ll wake up in a new Italy!”. The Five Star Movement is anti-establishment and anti-EU, and promised a universal basic income to bring 6.5 million Italians out of poverty – people it believes the former governments neglected.

While the Five Star party and Lega are both satisfied with the agreed budget, many opposition MPs and senior officials in the European Union, and even the Economy Minister Giovanni Tria, all oppose such a high deficit level, with the belief being that Italy should focus on paying off its large debts.

This morning the FTSE MIB, Italy’s primary stock market, is down between 2.7% and 2.92%, while markets across Europe are also suffering. The FTSE 100, CAC 40, and the Eurozone’s STXE 600 are all down around 0.3%, while Germany’s DAX is feeling the strain more at 0.68% - an indication of how key Germany’s economic strength is to maintaining Europe’s overall stability.

There have also been heavy losses for the Italian banks as share values have dropped on average by 6% – the largest one-day decline since 2016. Investors are fearful that Italy is either not taking its debt seriously or ignorant to the threat that such large debts present, with the notion of defaulting still lingering.

In response, Italy’s two-year, five-year, and 10-year bond yields are all higher, pointing to a lower price per bond as the Italian government seeks to maintain investor interest in the country despite the concerns over debt management. The graph below from Holger Zschäpitz, Senior Editor of the financial desk at Welt, shows the rise in yield for the 10-year bonds.

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“An accident waiting to happen”

Holger Schmieding, the Chief Economist at Berenberg Bank, Hamburg, is the man who believes disaster is imminent for Italy. Speaking to The Guardian newspaper he said that Italy’s debt is at crisis levels and the country has been their biggest home-grown risk since 2016.

“Italy is bringing itself into a precarious position. In the long run, Italy’s structurally weak economy cannot afford the reversal of the 2011 pension reform and 2015 Matteo Renzi’s labour market reform.

“Because Italy’s underlying fundamentals are shaky, it may not take much to trigger a major selloff in Italian bond markets that would weaken banks, tighten financing conditions and dampen economic growth further.

“The increase in social spending might also lead to credit rating downgrades increasing pressure on the sovereign bond yields.”

This morning the EU responded to Italy’s decision, with an interview on French television by Pierre Moscovici, the European Commissioner for Economic and Financial Affairs.

In his interview, Mr Moscovici said: “If Italians continue to get into debt, what happens? The interest rate increases, and the cost of servicing debt becomes greater. Italians must not be mistaken: every euro more of debt is one euro less for the highways, for schools, for social justice.

“We have no interest in a crisis between the Commission and Italy, nobody has an interest because Italy is an important eurozone country. But we don’t have any interest either that Italy does not respect the rules and does not reduce its debt, which remains explosive.”