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Italy's budget crisis threatens the entire EU project, strategist says

Key Points
  • The ongoing confrontation between the anti-establishment government in Italy and the European Commission has intensified over the last weeks, with Rome insisting on increasing its spending next year.
  • The dispute has also caused unease among market players. The yield on the 10-year Italian bond returned on Friday morning to levels not seen since 2014, hitting 3.73 percent as the dispute with Brussels intensified. 
VIDEO2:2802:28
Not confident Italy budget solution will be found soon, analyst says

The European Union needs to be "sensible" in how it deals with the Italian budget crisis or the entire project could come to an end, one strategist told CNBC Friday morning.

The ongoing confrontation between the anti-establishment government in Italy and the European Commission has intensified over the few last weeks, with Rome insisting on increasing its spending next year, despite the EU's disapproval. The concern in Brussels is that the higher spending will increase Italy's debt pile, which is already the second largest in the euro zone.

"I think it is important the European Union give them some leeway and allow them to have some kind of deficit," Bryn Jones, head of fixed income at Rathbones, told CNBC on Friday morning.

"I think the Italians are actually in a very strong negotiation position. If they (the EU) don't want to jettison Italy from Europe, the whole project dies. They have to be quite sensible," Jones said on "Squawk Box Europe."

On Thursday, the Brussels-based institution sent a letter to the Italian finance minister, Giovanni Tria, warning him that the 2019 budget draft seemed to point to a "particularly serious non-compliance with the budgetary policy obligations laid down" in European rules.

The Italian government has until Monday to reply to the commission's latest letter. If from that response, the commission still believes that the budget is in serious non-compliance, it has two weeks to adopt an opinion and request a new draft budget within three weeks.

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Italy's situation is 'pretty worrisome': Dijsselbloem

The dispute has also caused unease among market players. The yield on the 10-year Italian bond returned on Friday morning to levels not seen since 2014, hitting 3.73 percent as the dispute with Brussels intensified.

Jones told CNBC that despite the high yield, which gives investors high returns, he would rather wait to see what happens before taking a position.

"The yields are currently very high, but I wouldn't be adding to them until this story plays out a little bit. I am not that confident that we will get to a solution in the very-short term," Jones said.

Earlier on Friday, the previous head of the Eurogroup, dubbed the Italian budget story as "pretty worrisome." Jeroen Dijsselbloem, told CNBC that if Italy were to turn into a crisis mode, it would be an "implosion," given the way that its economy is organized.

"If the Italian crisis becomes a major crisis, it will mainly implode into the Italian economy ... as opposed to spreading around Europe," he said. "Because of the way that the Italian economy and the Italian banks are financed, it's going to be an implosion rather than an explosion."

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EU: Italy's 2019 draft budget a serious breach of EU rules