Italy clashes with the EU
What happened?
On Monday, the European Commission sent back Italy’s 2019 draft budget saying the proposed plan was breaking EU rules.
Why did this happen?
For months now, the European Commission has warned Italy to revise its budget. At 131% of GDP, Italy is the second most indebted member of the eurozone. The EU has said the proposed deficit – equal to 2.4% of GDP – is irresponsible. This is why the EU used this power to send back a budget for the first time.
How has Italy responded?
Today the Italian government refused to budge, signaling it would continue with its budget. This is the first time a eurozone member has challenged a formal reprimand from the EU since 2013.
Both leaders of Italy's coalition government – which came into power in May 2018 – have come to power on an anti-EU platform. They claim the budget is needed to kickstart the economy and have large benefit promises to meet. Promises which require spending.
What happens now?
Under EU rules, Italy has three weeks to revise its budget. If Italy doesn’t, the EU has the power to impose sanctions on the third-largest eurozone economy.
How does the market feel about this?
The yield spread between Italian and German government 10-year bonds has risen to unsustainable levels. This is the interest Italy pays to borrow compared to Germany. It’s a sign of the market’s lack of confidence in Italy.
Last week, the rating agency Moody’s dropped its rating for Italian bonds to one level above junk. Investors are eyeing another rating agency, Standard & Poor, which will update its rating of Italy’s government bonds on Friday.
Why is this an important story?
Less than a decade ago, the International Monetary Fund had to bail out Greece, Portugal and Ireland. What happened to Greece during the eurozone crisis shows the consequences of trying to defy the markets.
The question is whether Italy will continue to defy the EU. If they turn back now they will lose face. But if they don’t, Italy’s economy will suffer. There’s also a risk – like we saw in 2011 – that uncertainty over Italy spreads to other eurozone countries with high levels of debt.
