2014 Budget Offers Little Hope For Debt Reduction
Despite newfound political stability ( see 'Berlusconi Exit Bolsters Stability, For Now', November 25) that has limited policy risks, supported investor sentiment and aided the passage of a fiscally conservative 2014 budget , Italy's borrowing costs are set to rise due to both domestic and external factors. With both real and nominal economic growth to remain anaemic in the coming years according to our forecasts, this has negative implications for Italy's ability to contain its massive public load, even if the government is able to achieve further deficit consolidation.
Italian sovereign yields have been supported by robust demand from the domestic banking sector, which since October 2010 has increased its holdings of government securities by 142.4%. However, we believe that the banking sector is approaching a saturation point heading into 2014 ( see 'Banking Union No Cure For Sector's Woes', December 19), implying a need for increased foreign participation. Increasingly attractive returns on safer government debt securities will pressure Italian rates in 2014, which we expect to rise in tandem with more stable developed state yields. In our view, rising sovereign yields across the US, UK and Germany are a symptom of accelerating economic activity and relatively robust levels of nominal GDP growth, which bodes well for the ability of these countries to reduce public debt loads that have risen sharply during the global economic downturn.
This contrasts to Italy, where rising yields and low nominal GDP growth will limit the scope for debt reduction. Although Italy's recently passed 2014 budget does indeed signal a commitment to bringing the country's budget deficit to below the EU mandated 3.0% of GDP limit, in our view it does little to boost the country's potential growth in the coming years. With public debt to remain uncomfortably high, and still exposed to potential banking sector turmoil, Italy's sovereign risk premium will remain well above its more stable developed peers and vulnerable to volatility in global risk appetite.
|Borrowing Costs Heading Higher|
|Benchmark 10-Year Government Yields, %, Daily (LHS) & Weekly (RHS)|