Italian bond yields eased as President Sergio Mattarella approved a coalition government of the populist Five Star Movement and the far-right League, ending an immediate political crisis in the eurozone's third-largest economy. But any market truce may prove temporary.
The yield on 10-year government debt fell as low as 2.645%, before trading down 8 basis points at 2.717% by 9:48 a.m. ET. It had breached 3% for the first time in four years at the end of May, as drawn-out talks looked set to deliver a government bent on leaving the euro, prompting Mattarella to veto the coalition's initial proposal of vocal euroskeptic Paolo Savona as finance minister.
Investors now seem to have been placated by the avoidance of fresh elections, almost three months after March's national vote left Five Star as the largest party, with 32.2%, and the League, originally northern separatists before a tilt to the nationalist far right, third with 17.7%. The eventual choice of finance minister — academic Giovanni Tria — has helped to calm nerves, although Savona will serve as minister for Europe, under Prime Minister Giuseppe Conte, who was also plucked from academia by his populist sponsors.
Prime minister and president. Source: Associated Press |
Investors had feared a return to the polls would act as a de facto referendum on Italy’s place in the eurozone, but analysts pointed out that risks remain.
"The risks of a renewed surge in Italian bond yields have diminished following the formation of a government there. But the new administration is on a collision course with the EU and tensions may flare up again before long," research consultancy Capital Economics said in a note.
Holger Schmieding, chief economist at Berenberg, said the marriage of the two radical parties could put the country on a dangerous trajectory if they pursue a high spending agenda which includes plans for cutting the maximum rate of income tax to 20%, introducing a minimum basic income, and reversing an increase in the retirement age. Italy's debt is already running at 131% of gross domestic product.
"In retrospect, the market turmoil can be seen as a stern warning that they are playing with fire. Their key problem is not a potential noisy confrontation with the EU but their ability to finance their spending plans."
It is unlikely for now that the new government will act on its constituent parties' previous rhetoric in favor of leaving the euro, said Schmieding. But he cautioned a debt crisis would be possible if the government leaves Italy’s economy exposed.
"Even if a major calamity can be avoided for now, a half-reformed Italy that takes some steps in the wrong direction will be vulnerable when the next recession, due perhaps in 2021 judging by current U.S. cyclical dynamics, exposes Italy’s underlying weakness," he said.

