Italy's populist government defies the EU, sticking to its 2019 budget targets

  • Italy clung onto its contested budget deficit figure of 2.4 percent of gross domestic product (GDP) on Wednesday.
  • Italy's deputy prime minister reportedly said it would be "wrong" if the EU fined his country for breaching fiscal rules.
  • Italian bond yields ticked higher while the euro came under pressure.

Italy's populist government said it would stick with its high-spending budget plan, in a rejection of calls by the European Union to revise its fiscal targets.

Rome clung onto its contested budget deficit figure of 2.4 percent of gross domestic product (GDP), a move which is likely to send tremors into domestic and European capital markets Wednesday.

The 2.4 percent proposed deficit dwarfs the previous Italian administration's deficit goal of 0.8 percent of GDP.

Italy also kept its growth assumptions for 2019, 2020 and 2021 unchanged, despite both the EU and the International Monetary Fund (IMF) claiming those assumptions are too high.

Matteo Salvini, Italy's deputy prime minister, said overnight that the government would stick to its budget targets for 2019, but would up asset sales and keep spending in check.

Tuesday was the official deadline for the Italian government to submit a revised draft budget to the EU's executive body, the European Commission.

The Commission made the unprecedented move last month to reject Italy's draft budget proposal, stating the country's spending targets went against European rules.

Italys Labor and Industry Minister and deputy PM Luigi Di Maio (L) and Italys Interior Minister and deputy PM Matteo Salvini smile before the swearing in ceremony of the new government at Quirinale Palace in Rome on June 1, 2018. 
ALBERTO PIZZOLI | AFP | Getty Images
Italys Labor and Industry Minister and deputy PM Luigi Di Maio (L) and Italys Interior Minister and deputy PM Matteo Salvini smile before the swearing in ceremony of the new government at Quirinale Palace in Rome on June 1, 2018. 

Salvini reportedly said Wednesday that it would be "wrong" if the EU fined his country for breaching fiscal rules. "They've got it wrong if they are even just thinking of imposing fines on the Italian people," he told Italy's state-owned radio station RAI, according to Reuters.

Italian stocks were the worst performers in Europe on the back of the government's rebuff of Europe's call for a revision to the 2019 budget plans. The FTSE MIB fell more than 1.8 percent on Wednesday morning.

The yield on Italy's benchmark 10-year bond ticked 9 basis points (bps) higher to a three-week high of 3.54 percent following the news, amid increasing fears of an escalating standoff between Rome and Brussels.

The euro meanwhile came under pressure on the back of the news, shedding gains from earlier in the morning. The single currency had initially jumped after news that a draft divorce agreement had been reached by the U.K. and the EU. It was just a touch below the flatline in early morning trade.

Italy's government did however say in its resubmitted budgetary plan that it expected public debt to fall to 129.2 percent of GDP in 2019.

'Chicken and egg'

Worries around Italy's spending promises — which include an initiative to introduce a universal basic income and tax cuts — as well as an escalating confrontation with the EU have sent Italian borrowing costs higher and widened the gap between Italian and German bond yields.

Salvini, who is also leader of the right-wing populist Lega party, has said he watches bond spreads "every morning, before calling my kids," in a bid to assuage concerns that his government is ignoring investor concerns.

Michele Geraci, Italy's undersecretary of state for economic development, said Italian debt markets were currently in a "chicken and egg" situation.

"Investors are currently concerned because the yield is high and (because) the yield is high, (that) makes investors concerned and so on," he told CNBC's Joumanna Bercetche in an interview.

"But once people focus on the fundamentals ... that should in itself give you a yield which should be at almost risk-free levels."

'Irresponsible'

But a former member of the European Commission warned that Italy was setting itself up for "defeat," arguing that the government "cannot overrule the European framework."

"I think it's a very irresponsible attitude from the Italian government and I hope ... the Italian government will give up and will recognize that they cannot defy these rules, thinking in their own interests," Joaquin Almunia, formerly a European Commission vice president and commissioner for competition, told CNBC's Joumanna Bercetche.

"The problem is that if with this 2.4 percent deficit, the path of the public debt in Italy will not come to a sustainable point, Italy will pay the consequences," he added.

"I hope that the Italian government will recognize that the best way out of the difficult economic situation in Italy with the low growth and with lack of expectations is to moderate the deficit in the present budget."