EU rejects Italy's budget plan for 2019, sending bond yields higher

  • Rome has said it plans to incurs a budget deficit of 2.4 percent of GDP in 2019.
  • The European Commission has told Italy that it must make revisions to its draft budget proposal.
  • Italian bond yields have risen while Milan-listed stocks have sold off.

The European Commission, the EU's executive arm, told populist lawmakers in Italy that it must make revisions to its draft budget proposal.

Rancour between Rome and Brussels has grown in recent weeks after a controversial draft Italian budget for 2019 proposed a deficit equal to 2.4 percent of the country's annual output. A previous Italian administration had promised a deficit goal of just 0.8 percent of GDP (gross domestic product).

In a press statement in Strasbourg, the European Commission Vice-President for the Euro and Social Dialogue Valdis Dombrovskis said there was no alternative but to reject Italy's current proposals, before adding that the country's government now had three weeks to come up with another plan.

"Unfortunately the clarifications were not convincing to change our earlier conclusions of particularly serious non-compliance," said Dombrovskis before adding: "The Italian government is consciously and openly going against commitments made."

The commissioner also said that Italy risked becoming trapped by debt and claimed that in 2017, Italy spent the same servicing its debt pile as it did on education.

"Breaking rules can appear tempting at a first look, it can provide an illusion of breaking free. It is tempting to cure debt with more debt, but at some point the debt weighs too heavy," he added.

It is the first time that the European Commission has effectively rejected a draft budget proposal by a member country.

Italian bond yields rose in anticipation of the decision and the benchmark 10-year yield accelerated to a session high after the announcement was made official. Bond yields move inversely to prices. Speaking to CNBC's Joumanna Bercetche after the statement, Dombrovskis highlighted the recent "substantial increase" in Italy's borrowing rates, saying it was a signal that lawmakers should adjust the "fiscal trajectory."

Stocks listed on the FTSE MIB in Milan also sold off and the index closed down 0.8 percent on Tuesday afternoon. In recent months, concerns over Italy have even managed to roil U.S. markets on certain occasions.

There are fears in Brussels that Italy's fiscal plan will derail the reduction of the country's debt pile — which is the second largest in the euro zone, totaling 2.3 trillion euros ($2.6 trillion). Within Europe, countries are expected to not run an annual deficit greater than 3 percent of GDP. However, in Italy's case its debts have led to Brussels requesting that Rome work toward balancing its books.

The country's populist and partly right-wing coalition, voted in after elections in March, want the fiscal blowout in order to make good on pre-election spending pledges.

Italy's Deputy Prime Minister Luigi Di Maio, part of the left-leaning Five Star Movement, claimed on Tuesday afternoon that the EU ruling was no surprise, but said that Italy could not continue with past policies that enforced low fiscal spending. According to Reuters, Di Maio added that the EU Commission should treat Italians and their government with respect.