France’s debt turmoil has brought Europe’s fiscal pressures into sharp focus in recent weeks, but investors’ attention has quickly turned to Italy amid controversy over new government spending plans.
The Italian government is expected to present a budget next week that includes recently approved allocations for defense and energy, which will widen the budget deficit over the next two years and put Italy on track to have the highest debt-to-GDP ratio in Europe, according to analysts at Goldman Sachs.
Filippo Taddei, Goldman’s senior European economist, said the changes could put more pressure on Italian bonds ahead of next year’s general election.
On October 2, Prime Minister Giorgia Meloni’s centre-right government approved additional borrowing of 28 billion euros ($31 billion) over the next two years for defense and energy spending. Although spending plans were scaled back, Italy’s 2027 deficit target was raised to 3.4% of GDP and the 2028 target to 3.2%. That’s up from early April forecasts of 2.8% and 2.5%, respectively, and also beat Goldman’s forecast.
Italy’s 10-year BTP.
The measures, split evenly between defense and energy, each amounting to about 0.3% of annual GDP in 2027 and 2028, come amid growing investor anxiety over runaway government borrowing across the continent.
French debt crisis
Yields on French government bonds have risen to multi-year highs in recent days as the country’s deepening debt crisis raises concerns about Europe’s fiscal strain.
french benchmark 10 years OAT Yields fell 3 basis points to 4.85% on Friday as oil prices fell. yield Italy’s 10-year BTP The last seen was 5 basis points lower at 4.55%. the space between 10-year German Bundestagthe eurozone debt benchmark, Italy’s BTP was around 108 basis points by 1:40 p.m. Central European Time (7:40 a.m. ET).
Taddei said Italy’s fiscal risk premium could rise ahead of the next general election, scheduled by December 22, 2027 at the latest, due to the widening budget deficit.
A close election could leave little room for fiscal consolidation, he explained, as both parties on the right and left look to “add partners to help with spending” to build a viable coalition.
“After four years of fiscal consolidation, the debt outlook appears likely to weaken due to easing fiscal policy, tightening financial conditions, and a close election campaign,” he said in a note Thursday.
“Significant upside surprise”
Italian lawmakers voted Thursday to overhaul the country’s election process, switching from a hybrid model to a more proportional system. Meloni’s right-wing coalition argues the changes will stabilize the government and avoid chaotic post-election deals.
But left-wing opponents claimed the changes were aimed at helping Meloni cling to power.
French 10-year OAT.
Meloni’s government, which will table its final pre-election budget next week, has been praised for reducing the budget deficit, which reached 3.1% in 2025.
Meanwhile, the bond market has rewarded the country’s new political stability, with Meloni recently becoming Italy’s longest-serving leader since World War II.
The spending increase is in line with the EU’s national exit clause, which grants member states temporary budget flexibility for defense and energy investments to cope with shocks caused by Russia’s war in Ukraine and conflicts in the Middle East.
Still, Taddei said the new deficit target was a “significant upside surprise”.
“Rising yields, combined with rising fiscal deficits, will keep the debt-to-GDP ratio on an upward trend until 2028, by which time it will stabilize at around 137%, the highest level in Europe,” Taddei said.
“Rising yields are a key issue in the current environment, and we find that a structural shift to 10-year bond yields above 4% will likely cause Italy’s debt-to-GDP ratio to rise beyond that.”
“Difficult financial decisions”
Konstantin Veit, a portfolio manager at PIMCO, said the recent drop in global bond yields has put a renewed focus on countries with weaker fundamentals.
Veit pointed out that while French government bonds are widely held by foreign investors and are exposed to negative news flows, Italian government bonds, in contrast, are mainly held domestically, which is usually a “stabilizing factor”.
“Although Italy’s debt is increasing, its primary balance is stronger, it is on a relatively good trajectory, it is politically stable and has a history of making necessary adjustments,” Veit said.
He added that compared to France, Italy appears to be in a “relatively better situation” overall at this stage, due to “stronger fundamentals, a simpler political structure and a track record of making difficult fiscal decisions.”
But investors are already eyeing opportunities in Italian government bonds.
Reinout de Bock, head of European rates strategy at UBS investment bank, recently revealed a short position in Italy’s BTP, betting that Italian government bonds could emerge as the next weak spot in European government bonds.
“I think Italy will probably catch up. Even though they’ve had a lot of reforms in the past, getting yields this high is going to make people even more concerned about Italy,” Debock told CNBC’s “Squawk Box Europe.”
