- On 27 September the Italian government set a deficit target of 2.4% of GDP for 2019, well above what had been agreed.
- Italy’s risk premium soared again and a clash opened with the European Commission.
- Doubts over the public accounts of a euro country influence the cost of money across the whole region: they are worth watching.
On 27 September 2018, the Italian government set a deficit target of 2.4% of GDP for 2019, well above what had been agreed. The decision sent the country’s risk premium up again and opened a clash with the European Commission, which is responsible for ensuring compliance with the euro area’s common fiscal rules.
The episode matters because Italy is one of the Union’s largest economies and its public debt is very high. For its authorities to decide to depart from what was agreed raises doubts not only about the country itself but also about the euro area’s ability to manage disagreements between its members. The single currency shares monetary policy, but each state keeps its own fiscal policy, and that combination requires mutual trust. For business owners and families, it is an occasion to understand better how fiscal policy and the cost of money are related.
What the public deficit is
The deficit is the difference between what a state spends and what it takes in over a year. Euro-area countries undertake to respect agreed limits, and the European Commission monitors compliance. A target far above what was agreed immediately raises doubts among investors.
When a state spends more than it takes in, it must finance the difference with debt. If that debt is already high, the risk grows: investors wonder whether the country will be able to repay it and demand a higher return to lend to it. The common fiscal rules aim to prevent a country from accumulating imbalances that end up affecting the others, which is why breaching them is not considered a purely national matter. When one country’s debt causes concern, investors may become more cautious about others.
The market reaction
Italy’s risk premium rose again because investors demanded a higher return in exchange for lending to a state that was defying the rules. It was the second time in a few months that doubts over Italian policy were reflected in its financing costs.
Markets do not wait to know every detail before reacting. It is enough for greater risk to be perceived for debt prices to adjust. That sensitivity explains why political news has an immediate effect on prices and financing costs, and why governments have to weigh the effect of their announcements on the confidence of those who lend them money. What leaders say and do thus has measurable economic consequences.
A matter that affects everyone
The stability of the public accounts of a euro-area country influences the cost of money across the whole region. For companies and families with debts or investments in euros, watching these episodes helps to understand when financing conditions change and to decide in good time.
A practical way to do so is to review from time to time the terms of one’s own debt and the maturities coming up, and to consider whether it is worth bringing forward a renegotiation while the environment is stable. It also helps to avoid excessive concentration of investments in the debt of a single country or issuer. A financial adviser can help review the exposure and set out alternatives without the decision depending on the headline of the day. What matters is not to catch the exact moment, but for the debt structure to be sound under different scenarios.
Common fiscal rules protect the whole; when they are questioned, the market notices at once.
This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.
