Proposals for 2019 put the country on a potential collision course with the EU

This article is more than 1 year old

This article is more than 1 year old

Fears that Italy is on a collision course with the EU over its spending plans triggered sharp falls in European markets after the new government in Rome unveiled a deficit-widening budget.

The coalition of the Five Star Movement and the League announced 2019 budget plans late on Thursday that would push the deficit – the gap between income from taxes and expenditure – to three times the size of the spending gap under the previous administration.

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Though within the prescribed EU limit of 3% of GDP, the proposals rattled traders, who fear the anti-establishment parties are not committed to tackling the Italian debt pile, which at about 130% of GDP is the biggest in the eurozone behind Greece.

The plan from the coalition of the League leader, Matteo Salvini, and the Five Star Movement leader, Luigi Di Maio, will push the deficit to 2.4% next year, despite suggestions from the country’s technocratic finance minister, Giovanni Tria. In recent weeks, Tria had indicated that the figure was likely to be below 2%.

Italian government bonds dropped on Friday, pushing up the cost of borrowing on international markets for the country, while there was a sell-off in bank stocks. The yield, or interest rate, on Italian debt rose to 3.2% as investors priced in higher risk.

Italian stocks fell by more than 3% on the FTSE MIB index in Milan, while there were also losses in Germany, where the Dax fell 1.5%, in Spain, where the Ibex fell 1.5%, and in France, with a decline of 0.9% on the CAC. In London, the FTSE declined by 0.5%.

Italy’s banking index was down 6%, with shares in the country’s two largest banks, Intesa Sanpaolo and UniCredit, also falling by 6%.

There are fears that problems in the Italian banking sector could spread to other EU countries, including France, Spain and Portugal, with the potential to reignite a financial crisis across the eurozone.

Prof Costas Milas of Liverpool University’s Management School said: “The Italian ‘virus’ has the potential to spread rapidly in other EU countries.”

Wall Street opened lower amid concerns over the situation in Italy and lingering fears over the US trade dispute with China, before American stock markets staged a gradual recovery in afternoon trading in New York.

Salvini and Di Maio heralded the budget proposal as one designed to end poverty, in a country where youth unemployment has soared since the financial crisis and GDP has failed to return to its pre-crisis peak.

Some economists argue Brussels should give the country a wide berth to stimulate its economy with greater government spending and tax cuts, because an austerity-driven approach over the past decade has largely failed.

The government plans to push ahead with a minimum income for those out of work, new welfare policies and more generous pensions. Funding a universal basic income will cost €10bn (£8.9bn), which Di Maio says will lift 6.5 million people, long ignored by previous administrations, out of poverty.

Compared with the previous government’s target for a deficit of 0.8% next year, the largest contribution to the widening gap between income and spending comes from the repeal of the planned January 2019 VAT increase, which economists said was worth 0.7% of GDP.

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Further details are yet to emerge about the Italian spending plans. Italy must submit a draft budget to the European commission for review by 15 October. The Italian parliament will debate and vote on the plan before the end of the year.

Investors, however, are concerned that tensions between Italy and the EU over its proposals could become inflamed in coming weeks. There are also fears the coalition may fail and snap elections could be called.

Pierre Moscovici, the European commissioner for economic and financial affairs, warned increasing the Italian government deficit would raise the cost of paying back its loans. “Italians must not be mistaken: every euro more of debt is one euro less for the highways, for schools, for social justice,” he said on Friday.