A rally in Italian government bonds has narrowed the closely watched gap between the country’s borrowing costs and Germany’s to the lowest level in more than two years, as investors become increasingly optimistic about the prospects for Italy’s economy and position for interest rate cuts.
The so-called spread, or gap, between 10-year borrowing costs in Italy and Germany sank to 1.16 percentage points on Thursday, its lowest level since November 2021, before rising back to 1.23 percentage points. That marks a major turnaround from a level of more than 2 percentage points as recently as October, reflecting growing market confidence in Prime Minister Giorgia Meloni’s handling of the economy, at a time when growth in Germany has stalled.
“Three or four months ago, few could imagine that the spread today, in mid-March, could be 123 basis points,” Italian finance minister Giancarlo Giorgetti told the Financial Times ahead of Thursday’s moves.
He added that he hoped the gap in borrowing costs — known locally as “lo spread” — would “continue in this direction” to 110 basis points as Rome tried to shrink its budget deficit and easing interest rates helped lower debt servicing costs.
The sharp fall in the spread defies many commentators’ early fears that the election of Meloni’s rightwing bloc in September 2022 would unleash a populist spending splurge and put strain on Italy’s relationship with the EU. However, Meloni has defied those expectations, as her government has pursued a path of fiscal rectitude and forged a strong working relationship with Brussels.
Concerns resurfaced last autumn when the government said it would not bring the country’s budget deficit below the limit set by the EU until 2026.
However, since then Italy’s economy has performed relatively well while the outlook for Germany has darkened and Chancellor Olaf Scholz’s government has lurched from crisis to crisis.
The tightening of the spread also reflects investors’ hunger for high yielding assets ahead of expected European Central Bank rate cuts this summer, as well as the relative resilience of the Italian economy.
Benchmark German government bond yields have risen from 2.03 per cent to 2.42 per cent since the start of January. The equivalent Italian borrowing costs are 3.67 per cent, having started the year at 3.7 per cent. Yields move inversely to prices.
The Italian public has been familiar with “lo spread” since the eurozone debt crisis more than a decade ago, when worries about Rome’s debt sustainability or a potential exit from the currency bloc caused the gap to widen dramatically to more than 5 percentage points at its peak in 2011.
The falling risk premium on Italy’s debt this year is welcome news for Meloni. In recent days, she has visibly revelled in the success of recent Italian bond issues and the narrowing spreads, which she declared was a reflection of “perceptions of the solidity of the economy”.
Italy’s economy grew in the final quarter of last year while Germany’s contracted. This unusual outperformance could continue, with the Bank of Italy forecasting 0.6 per cent growth this year, while the Bundesbank only expects 0.4 per cent for Germany.
“Italy hasn’t changed for the better or the worse, but Germany all of a sudden has become a risky country,” said Francesco Giavazzi, who served as economic adviser to former prime minister Mario Draghi. “Markets are starting to get a bit worried.”
The performance of Italy’s bonds comes in spite of its huge debt pile, which rating agency Fitch forecasts will edge higher to 140.6 per cent of gross domestic product this year. In contrast, Germany’s will drop to 64.1 per cent, the agency forecasts.
Italy also has a heavy issuance programme to help service its debt, with interest costs set to rise above 9 per cent of government revenues this year, the agency forecasts. Even though Italy’s budget deficit is forecast by UniCredit to shrink to 4.6 per cent this year, that is still much higher than the 2 per cent forecast for Germany.
“It’s true that Italy is doing better than Germany growth wise and that is unusual,” said Tomasz Wieladek, chief European economist at T Rowe Price. “Better macroeconomic conditions are dominating worse fiscal fundamentals.”
The speed of the narrowing of the spread has taken many investors by surprise. Some attribute it to appetite for higher yielding assets as the European Central Bank gets ready to begin cutting interest rates.
“People have been quite taken aback over the past two weeks, the spread crossed 1.5 percentage points and since then it’s just been in freefall,” said Lyn Graham-Taylor, a senior rates strategist at Rabobank. There has been an attitude among many investors to “go long unless definitively told otherwise and enjoy the carry [higher yields]”, he said.
Italian bonds have been buoyed by a flood of money from retail investors. Meloni has emphasised the importance of retail ownership of Italian debt, and the country’s ‘BTP Valore’ bonds, which are sold exclusively to individuals and provide a bonus to those who buy them at issue and hold until maturity, have raised €53.7bn since June across three tranches.
“It’s a very important element for us, that I am not hiding from you, that our goal is to put the greatest possible part of Italian debt in Italian hands,” said Meloni at a function on Tuesday. “The more you are the master of your debt, the more you are the master of your destiny.”
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