The market-rattling game of chicken between Rome and Brussels has ended in a draw.
EU officials confirmed Wednesday that after a meeting in Brussels with leaders from Rome, the two sides have struck a deal on the Italian budget deficit that will allow Italy to move forward with its plans to expand welfare benefits and tax cuts while avoiding the threat of billions of euros in fines.
EU commission vice-president Valdis Dombrovskis said the agreement that had been reached would lead to an expected budget deficit next year of 2.04% - a number of redundantly laughable precision - of GDP compared with 2.4% in Rome’s original plans.
The euro climbed, European bank stocks rallied and Italian bond yields moved lower after EU officials, who had been meeting with Italian Prime Minister Giuseppe Conti and other government officials in Brussels on Wednesday, confirmed that they would abandon their plans for an "excessive debt proceeding" against Italy, the process for officially punishing an EU member found to be in violation of the bloc's stringent budget rules.
The FTSE MIB rallied over 1%, driven by rising shares of domestic banks (+2.9%). BTP futures surged higher, while the curve bull steepened with yields initially falling by 12bps in 2s and 5s. The euro rallied as anxieties about an 'Italeave' scenario faded.
However, these moves started to fade after EU bureaucrats made clear that they still have some reservations about the Italians' spending plans. The ECB’s Ewald Nowotny said the Italian budget "is not sustainable", and European Commission Vice President Valdis Dombrovskis said Italy's proposed 2019 budget "still raises concerns" and that the Italians "structural" budget adjust for 2019 will effectively be 'zero' (presumably due to the government's decision to lower its growth forecasts from 1.5% to 1% as growth falters). Because of the country's precarious debt burden, there is an 'urgent' need to set Italy on the path toward fiscal responsibility.
After the EU rejected the Italians proposed budget last month in what was an unprecedented decision that rattled the country's markets, Italy's ruling populist coalition decided that it would be willing to work toward a negotiated solution despite earlier claims that it would never kowtow to bureaucrats in Brussels. Earlier this month, reports suggested that the Italians would accept a deficit of 2.04% instead of 2.4% in return for the EU dropping its pursuit of financial sanctions that might have led to a banking crisis - or worse - in Europe's third-largest economy. Dombrovskis confirmed that these were the parameters agreed to on Wednesday during a meeting of EU leaders and leaders from Rome.
Dombrovskis said he hopes that the budget will be "the basis for balanced budgetary and economic policies in Italy," though he added that the agreement "is not ideal." Italy "urgently needs to restore confidence in its economy to ease financial conditions and support investment."
While the Italians have insisted that the stimulus is essential for reviving Italy's moribund economy, Brussels has warned that the additional debt burden would only add to the country's woes, and that Italy was "sleepwalking into instability." Brussels said it will continue to "monitor" developments in Rome. Wednesday had initially been the deadline for Italy to either amend its budget proposal or face the formal beginning of the EDP, which would have handed Italy deadlines to either mend its finances or face fines, according to the Financial Times.