Fixed Income

Mario Draghi to the rescue

Mario Draghi to the rescue

Bond markets will be anxious to know what the new Italian PM intends to do to improve Italy’s medium-term growth prospects and debt sustainability.

Ex-ECB president Mario Draghi was officially sworn in as new Italy's prime minister this weekend. His cabinet is made up of a mixture of political representatives and technocrats—eight ministers out of 23 are non-politicians, some of whom hold key cabinet posts such as that of economy and finance minister. From an economic point of view, we see the appointment of this new government as a positive development since it reduces political uncertainty and strengthens Italy's credibility when it comes to the design and implementation of the country’s post-pandemic recovery plan. The make-up of Draghi’s government is boosting market hopes for much-needed structural reforms in Italy.

 

Draghi has gathered the support of both the main populist formations, the League and the Five Star Movement. Their endorsement of this pro-EU government also reduces the ‘Italexit’ risk, whatever the results of the next elections (due by June 2023 at the latest) and should contribute to dampening further the volatility around Italian government bonds.

 

Indeed, Italian bond markets welcomed the news of Draghi’s acceptance to form a new government, with the yield on 10-year Italian sovereign bonds (BTPs) falling to an all-time low of 0.46% on 11 February and the spread versus the 10-year Bund reaching 91 bps.

 

The broad support for Draghi’s government means our year-end forecast of 90 bps for the 10-year Italian sovereign spread over Bunds has been hit much sooner. But we would not expect the spread to tighten much further, at least until more is known about the government’s agenda. The reforms that the Draghi government decides to prioritise and the details of its plans for the EU recovery fund will be closely scrutinised in the weeks to come. For the recent fall in BTP yields to be sustained, both reforms and EU money will need to be directed towards projects that boost Italy’s medium-term growth potential, thus easing the strain on public debt sustainability (Italy’s debt-to-GDP is set to exceed 160% of GDP in 2020 and 2021).

 

We will wait to see whether real change materializes that could improve Italy’s medium-term growth prospects, and thereby brighten the prospects for Italy’s debt sustainability.

 

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