Italy Blinks? Rome Said To Consider Cutting Deficit Target To 2.1%

In what may be confirmation that the recent turmoil in Italian bonds has finally spooked Italy's coalition government into "blinking" in its standoff with the EU Commission, newspaper Il Foglio reports that "some economic advisers" are pushing coalition partners to reduce Italy’s deficit target for 2019 as a result of pressure from Brussels (and bond vigilantes).

Specifically, the newspaper cites anonymous sources that some League and Five Star advisers would favor a reduction in the deficit target from the current 2.4% with 2.1% seen as possible compromise.

As a reminder, yesterday the commission rejected Italy's proposed budget, saying it was excessive, and the deviation from EU guidelines was "unprecedented."

Meanwhile, tensions within the ruling coalition are building up, Italian Deputy PM Salvini broke off from speaking events in northern Italy, where his party will fight a regional election Sunday, to return to Rome amid the standoff with Europe.

Bloomberg reported that while Italian markets tumbled Friday with the European Union shaping up to reject Italy’s 2019 budget, Salvini was embroiled in a spat with his coalition partner, Luigi Di Maio of the Five Star Movement, over tax policy. Specifically, Di Maio accused Salvini’s pro-business party, the League, of secretly sweetening a tax amnesty proposal that he’d only grudgingly agreed to in the first place. Salvini has denied any such thing ever happened and is flying back from Trentino near the border with Austria to thrash out the issue at a cabinet meeting in Rome at 1 p.m. on Saturday.

"Our enemies are outside, not inside the government -- let’s talk about this as a family," Salvini said in a Facebook Live video. Some Five Star lawmakers are acting as if they were in opposition to the government, he added.

The administration has been under fire from investors and the EU. With bond yields climbing, the 2019 spending program was attacked by several European leaders at a summit in Brussels this week as the European Commission warned that its budget draft won’t fly.

“If one breaks these rules and Italy diverges from Maastricht, then that means Italy is endangering itself and of course endangering others," Austrian Chancellor Sebastian Kurz told reporters Friday, referring to the Maastricht Treaty which governs the single currency. "We as the European Union are not prepared to take on this risk.”

The market was quick to punish Italy on Friday morning when the spread between Italian and German 10-year bonds reached a five-year high of 341 basis points on Friday after Premier Giuseppe Conte failed to convince his European partners that Italy should be allowed to flout the EU’s fiscal rulebook.

Even as Di Maio and Salvini have both ruled out making any changes to the budget as they seek to deliver on election promises including a “citizen’s income” for the poor, tax cuts and a lower retirement age, they are fighting over the planned tax amnesty.

Di Maio on Wednesday said that someone had changed the language in the government’s draft decree to allow Italians to get around the 100,000-euro ($115,000) limit that his party had insisted on. The League had pushed for a ceiling of 1 million euros, according to local press reports, and Di Maio was clearly pointing the finger at Salvini’s team.

Meanwhile, prime minister Conte said in a Facebook post that debate between the different coalition groups was at times "vibrant" but the government has "proved it is able to work as a team." However, growing acrimony within the coalition has cast doubt whether Italy's biggest foes are indeed "outside", and whether the lack of a compromise won't lead to a collapse in the relatively new populist government.