Key Takeaways
- The government is working on the 2026 budget at a time when government bond yields are stable and the BTP-Bund spread is at a 15-year low.
- Italian government bonds are benefiting from investor demand, political stability, and efforts to consolidate public finances.
- Measures such as freezing the retirement age could derail public finances, but economists expect the government to remain committed to its fiscal targets.
The debate on the Italian autumn budget has entered a critical phase with the political debate on the Draft Budgetary Plan, which must be sent to the European Commission by mid-October and must contain the targeted budget balance and projections for expenditure and revenue. The next step is the 2026 Budget Law, which must be approved by December 31. Despite the heated debate in Parliament, economists are convinced that the Italian budget will not have a major impact on government bond yields.
Economists doubt that the government will deviate from its objectives of improving public finances with the 2026 budget.
“We expect the deficit to continue to fall below 3% in 2026”
Filippo Taddei, Goldman Sachs
“We expect the deficit to continue to fall below 3% in 2026,” said Filippo Taddei, senior European economist at Goldman Sachs. In fact, the Ministry of Finance Giancarlo Giorgetti is working to reduce the budget deficit to 2.8% from 4.3% in 2024, which would allow Italy to exit the European Union’s excessive deficit procedure.
According to Nicola Nobile, chief Italy economist at Oxford Economics, Italy’s fiscal trajectory is fairly constrained by the current EU fiscal framework, so there are no “significant risks” that could derail it. Furthermore, Nobile does not expect the autumn budget to include policies that could move financial markets.
“I believe the Ministry of Finance is deliberately downplaying the available fiscal space to avoid triggering additional spending demands from coalition parties,” said Nobile.
As a result, experts do not expect a surge in BTP yields caused by significant spending increases, drastic tax cuts, or pension measures.
According to Javier Rouillet, senior vice president of Morningstar DBRS’s Global Sovereign Rating team, the Italian government will “remain committed to its fiscal targets in line with its track record since taking office.” Rouillet adds that he doesn’t see “clear challenges to the stability of the Italian government now, which cements the credibility of its pledges.” However, he warns that the trend could falter or reverse if Italy’s economic or fiscal performance were to significantly underperform.
Nobile of Oxford Economics believes that the BTP-Bund spread could widen moderately - by around 20-40 basis points- over the medium term, but the reason for this would be mainly a “normalization towards fair value levels” rather than “fiscal-policy-induced market shocks.”
Gabriele Serafini, economist and professor at the Niccolò Cusano University in Rome, notes that the dynamics of the spread between Italian and German bonds will depend more on the public spending decisions of German Chancellor Friedrich Merz than those of Giorgia Meloni. “Italy will not worsen BTP rates, and the spread could only change in the event of an increase in bunds due to German spending maneuvers.”
Economists think that the reduction seen over the last year can largely be explained by the increase in bund yields following the announcement of Germany’s debt plan to boost infrastructure and defense spending, and by the increase in French yields caused by political instability and the deterioration of public finances.
10-year BTP yields have remained particularly stable at around 3.50% in recent weeks, apart from the peak on September 2 caused by the selloff on the bond markets after the fall of François Bayrou’s government in Paris.
However, there are also internal factors that explain the reduction in the spread, including the historically atypical period of political stability in Italy and high demand for government bonds from investors. While retail investors attracted by the Italian BTP Valore were the driving force from 2022 to mid-2024, there are now other players on the market.
" Italian sovereign spreads have reached the tightest level in 15 years, benefiting from growing demand by foreign investors and more recently from domestic financial entities," said Goldman Sachs’ Taddei, who adds that Italy’s post-pandemic economic growth and “relatively cautious” fiscal guidance have been crucial in anchoring investors’ expectation.
Goldman Sachs economists highlight three issues that could have an impact on Italian public debt:
- The increase of defense spending.
- Tax cuts for the middle-income earners, offset by a temporary increase in taxes on banks and equity buybacks.
- The reduction of immigration flows and the curtailment of the automatic adjustment of the statutory retirement age to the increase in life expectancy.
“Increasing defense spending and making tax adjustments are unlikely to derail the Italian fiscal trajectory, which currently looks encouraging,” said Taddei. “But our simulations suggest that lowering net migration or freezing the statutory retirement age could derail debt stabilization from 2027.” According to Goldman Sachs’ simulations, the debt-to-GDP ratio could increase by one or two percentage points compared to the baseline scenario by 2029. Currently, Italy’s debt, at 137.9% of gross domestic product, is the second highest in the eurozone after Greece.
On pensions, the government will have to address the issue of revaluation for 2026, based on this year’s estimate of inflation, currently at 1.7%. According to the initial calculations by the Ministry of Economy and Finance, approximately EUR 5 billion would be needed, for which adequate coverage must be found. Various options are being considered, including savings on interest expense resulting from the decline in government bond yields.
