Italian budget plan is based on optimistic growth and interest rate assumptions, while the revenue side remains vague.
Our base case is now that the EU Commission will give a negative viewpoint and ask for a revision of the budget, which risks triggering a populist backlash, but it will be a long road until EU sanctions are imposed.
One should not be complacent about Italian risks in the medium term, as the debt dynamics remain susceptible to a downturn in growth and/or rise in yields.
While 'Italian fiscal noise' may weigh on EUR /USD at times in the near term, we stress that USD positives remain more important.
Following last week's compromise reached on the 2019 budget deficit, the government has now finally released the full Economic and Financial Document (DEF) outlining the details and assumptions behind its new fiscal strategy.
Efforts by Finance Minister Tria to promote his government's new fiscal strategy to his euro area counterparts ended in failure on Monday and Commission President Juncker warned of a Greek-style crisis. Tria sought to explain his government's decision to breach the requirement of a structural balance improvement of 0.6pp in 2019 in the context of slower growth in the euro area and Italy and stressed that the deficit will still envisage a decline - although limited - in the debt-to-GDP ratio. However, senior European Commission officials have been unyielding and signalled that the planned deficit target would be considered a breach of EU fiscal rules.
The Italian budget projections are not yet set in stone (the parliamentary discussion on the fiscal plan started on Wednesday). In light of tough language from Brussels and President Mattarella's reported refusal to sign off on a deficit of 2.4% over three years, the government relented and lowered the planned 2020 and 2021 deficits to 2.1% and 1.8%, respectively. The president has already on previous occasions indicated that he will play an active role in ensuring debt sustainability and he has the right to veto government bills that are deemed unconstitutional and significantly violate the balanced budget requirement according to Art. 81.
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