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Italy unlikely to back down to Brussels yet, says Goldman Sachs

Key Points
  • Italy has had its first budget proposal for 2019 rejected by the European Commission.
  • Rome has indicated it will not reduce its spending plans by next Tuesday's deadline.
  • Goldman Sachs say it will take more market pressure before politicians in Rome cave to Brussels.
Goldman Sachs: Italian budget tensions are quite elevated

The Italian government is unlikely to back down from its 2019 budget deficit plan until market pressures rise, according to Goldman Sachs.

Euro zone commissioners have pressed Italy to amend its budget to abide by EU rules, and have given Italy until next Tuesday to revise spending plans to reflect a lower deficit projection.

Speaking after the euro zone ministerial meeting in Brussels on Monday, the Italian Finance Minister, Professor Giovanni Tria, said the budget "will not change." On Tuesday morning he appeared to reinforce that position when he that he expected to have further disagreements.

Jari Stehn, a senior economist at Goldman Sachs, told CNBC's Street Signs on Tuesday that near-term tensions remained high and a breakthrough in talks between Rome and Brussels would likely take time.

"We think that in the response next week the Italian authorities are probably not going to back away from their plan to increase the deficit" he said.

"We ultimately think that things might have to get worse before they get better in terms of market pressure," Stehn added.

Italian growth (gross domestic product) fell to zero in the third-quarter of this year and its government debt has ballooned to more than 2.3 trillion euros ($2.6 tn).

The yield on 10-year Italian sovereign debt is at 3.393 percent, near to its highs of 2018 and sitting at levels not seen since early 2014. Bond yields move inversely to prices.

Stehn said he expected that the cost of borrowing would have to rise further for Italy, before Rome's lawmakers would accede to EU rules.

"I think the market pressure is probably key here …. ultimately it is about the outlook for debt and the sustainability of debt," he said.

The economist said he didn't think Italian truculence over its debt plan would affect the European Central Bank (ECB) to end asset purchases this year.

Stehn said the Goldman Sachs house view remained that the ECB will raise one of its key benchmark interest rates "towards the end of 2019."

The ECB left its key interest rates unchanged at -0.4 percent at its Governing Council meeting last month but reaffirmed its plan to end monetary easing by the end of the year.