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Since last July, interest rates have been raised by the ECB for six consecutive times resulting in a cumulative increase of 3 percentage points in an effort to counter rising price pressures and stabilize inflation expectations around the medium term target of 2 per cent. Yields on Italian Government bonds have subsequently increased, yet the spread with German Bunds – a closely-watched measure of the country’s perceived creditworthiness – is below the 200 basis-point range, a level considered worth of attention but not alarming.
Largely, this reflects the policy stance of the Government led by Prime Minister Georgia Meloni, who is also ECR President. The Stability Law that her Cabinet presented before Parliament just a few weeks after being sworn in was balanced and sound. The envisaged fiscal expansion would be temporary aiming at mitigating the consequences of the energy crisis. Indeed, the debt-to-GDP ratio was projected to decline by the end of the three-year period.
But the year that has just started is different. Financial markets may be less willing to adopt a wait-and-see attitude. Rather, they will be closely watching measures adopted by the Government, including the new Stability Law for which there will be ample time to prepare for. Starting from March, the ECB will be reigning in the liquidity support that had previously extended by purchasing bonds of Eurozone countries in the secondary markets. As a result of that, the Eurotower now holds some 750 billions worth of Italian Government bonds in its portfolio that will not be rolled over upon expiration. That is going to translate in increasing yields demanded by market players to buy and hold bonds issued by the Italian Treasury.
Markets are not ideological about governments, yet they do require solvency from the sovereign counterparts they extend their credit to. For a high-debt country like Italy, the most promising path to fiscal sustainability is to ensure a steady growth path for its economy. This is why the Government’s agenda and narrative should squarely focus on growth-enhancing measures, ensuring steady delivery on RRNP’s milestones and objectives. The importance of achieving those milestones is two-fold: on the one hand, it helps persuade markets that Italy is serious about its growth agenda; on the other, it enables Rome to engage European partners on other strategic initiatives aimed at mobilizing large European funds for yet more investments.
As important as those achievements are, a consistent narrative should also follow through. It should reflect the Government’s sense of urgency in delivering growth and reforms. This is the best way to keep market expectations stable and the spread relatively narrow, while preparing for further belt-tightening by the ECB. Market yields have increased so far because of general market conditions and not for having the first Conservative-led Government in Italy. The latter should stay the course preventing escalating market pressures that would inevitably compromise its promised agenda of change and reforms that voters have been seeking.