Spreads on Italian debt could continue to drop, as Italy’s relations with Brussels become calmer. But much will depend on the new government’s durability and its commitment to reducing the debt burden.

President of the Republic Sergio Mattarella has instructed Giuseppe Conte to form a new government backed by a coalition of the Five Star Movement (M5S) and the Democratic Party (PD). Importantly, there are still many hurdles to overcome, and a last-minute breakdown in discussions cannot be ruled out.

There are strong political divergences between these two parties, but the new government’s attitude towards Europe should be less hostile and more constructive than the previous ones.

With the new coalition government almost a done deal, we have revised our 10-year Italian BTP – Bund spread target from 250 bps to 150 bps for year-end (the spread was 165 bps on August 29).

We believe the 10-year spread could even overshoot towards 120 bps, but for such spread tightening to be sustained we believe we would need to see a 2020 budget that clearly sets Italy’s debt-to-GDP ratio on a downward trajectory. This could prove difficult, as economic growth is close to 0% and politicians in Italy show little appetite for deficit reduction.

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