Italy Markets Rally as EU Holds Off on Budget Deficit Punishment

(Bloomberg) -- Italian markets extended a rally as the government avoided European Union sanctions after lowering its 2019 budget deficit target.

Bonds climbed to take 10-year yields to the lowest in three months and stocks led gains in Europe. The European Commission decided not to enforce its excessive deficit procedure at a meeting of top officials, confirming earlier reports, after Italy’s populist government pledged to rein in its spending.

Italy Markets Rally as EU Holds Off on Budget Deficit Punishment

“This leaves room for more convergence between Italy and the core-EU markets,” said Jens Peter Sorensen, chief analyst at Danske Bank A/S.

Italian bonds have undergone a recovery in recent weeks amid signs that the populist coalition would relent in its budget battle with the EU after the initial proposals breached the bloc’s deficit limits. Italy dropped its deficit target to 2.04 percent from 2.4 percent in an effort to appease the EU.

Italian 10-year yields fell 14 basis points to 2.80 percent, the lowest level since Sept. 26, while their spread over Germany dropped 13 basis points to 257 basis points. Two-year yields slid as much as 17 basis points to 0.38 percent, the lowest since May 28.

Italy’s benchmark index of shares rose 1.7 percent, its first gain in four days. Bank stocks outperformed and the FTSE Italia All-Share Banks Index climbed 3.6 percent.

Not Ideal

Negotiations resulted in avoiding penalties for 2019 though “the solution is not ideal,” Commission Vice President Valdis Dombrovskis told reporters in Brussels on Wednesday.

The nation remains one of Europe’s key risks next year, with signs of a rift between coalition partners Five Star Movement and the League adding to speculation that there could be a snap election. Economic growth is tepid, while weak demand for bonds at auctions throws doubts on its funding plans in 2019, especially as the European Central Bank caps its asset-purchase program this month.

“The first months of 2019 will be challenging for Italy from a funding perspective,” wrote UniCredit SpA strategists led by Erik Nielsen. “If the mood remains upbeat, selling debt is likely to be smoother, but the market mood can turn very fast, meaning that volatility is likely to remain elevated.”

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