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Bank of Italy warns coalition government against higher spending

Key Points
  • The current coalition government, in power for about a year, vowed to increase spending to boost the Italian economy. 
  • The central bank added that the risks of higher spending "must not be underestimated."
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The Bank of Italy has cautioned the anti-establishment government in Rome against widening the country's deficit.

The warning from the central bank comes at a time when tensions between the Italian government and the European Commission, which oversees fiscal policy across the EU, are running high. Earlier this week, Brussels sent a letter to Italy, asking the government to explain why the country's debt did not come down in 2018.

"To confine ourselves to seeking temporary relief by raising the public deficit could prove less than effective, even counterproductive, if this led to a deterioration in financial conditions and in the confidence of households and firms," the Bank of Italy said in its annual report Friday.

The central bank added that the risks of higher spending "must not be underestimated."

The current coalition government, in power for about a year, vowed to increase spending to boost the Italian economy. As a result, it has put forward initiatives such as a citizens' income (which aims to help out the poorest) and plans to lower the retirement age.

Such spending plans have raised eyebrows in Brussels, given that Italy has the second highest debt pile in the European Union. The European Commission alerted Rome last autumn that it had to bring down its deficit target for 2019 in order to reduce its debt pile. They both agreed to lower the government's initial deficit target from 2.4% and 2.04% at the end of 2018. However, the Italian government has had to revise upwards that target earlier this year.

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Speaking to CNBC in an exclusive interview, Ignazio Visco, Italy's central bank governor, said: "In the last 20 years, Italy has grown 1% less than the average of the euro area for every single year and (addressing lackluster growth) cannot be postponed. This is (an) absolute necessity."

Data released Friday morning showed that the Southern economy grew at a pace of 0.1% in the first quarter of this year. This is after having registered a recession at the end of 2018.

The Bank of Italy also said Friday that the high debt levels in Italy continue to be a "severe constraint."

According to data from the European Commission, released earlier this month, Italy's debt pile is set to reach 133.7% of GDP this year and to increase to 135.2% in 2020.

Governor Visco told CNBC's Willem Marx that the Italian government needs to show it is serious about bring down the debt levels.

"The credibility does not mean (the debt-to-GDP) has to be reduced today. It means you have to be credible in your ability to reduce the burden of the debt….by starting now," he said.

Italy's bank governor suggested that policymakers should focus on investment rather than providing subsidies.

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The government's plans and its battle with the EU over spending has sparked some volatility in the bond market, leading to higher yields. Ultimately, higher bond yields lead to higher interest rates on mortgages and other loans, which could be a drag on the overall economy.

Governor Visco told CNBC that so far the higher yields have not been translated into higher costs on mortgages, "except for a very minimal amount." However, he warned that Italy needs to work to increase investment confidence and ultimately keep borrowing costs lower.

The Bank is not under attack

The Bank of Italy and its governor have previously been blamed by the current government for the performance of the Italian economy in recent years.

Speaking to CNBC on Friday, Governor Visco said that the institution is independent.

"I don't think that Italy, the Italian public at large nor the Italian institutions and certainly not the president of the Republic, as far as I know, the ministry of finance and so on have any disbelief in the bank. The bank is autonomous, is independent."