Italy: Deficit set to jump putting pressure on spreads – ABN AMRO

In view of analysts at ABN AMRO, Italy’s recession points to much larger budget deficit as the economic outlook has deteriorated rapidly.

Key Quotes

“According to the official definition Italy’s economy entered a recession in the final quarter of last year, with GDP contracting by 0.1% qoq in 2018Q3 and by 0.2% in Q4. Since then, it seems to have moved even deeper into negative territory. Indeed, Italy’s composite PMI dropped to 48.8 in January, which is consistent with GDP contracting at a rate of around 0.3% qoq in 2019Q1. Due to the longer than expected recession, we have reduced our GDP growth forecast for 2019 as a whole to -0.3%, down from our previous forecast of +0.3%.”

“The deteriorating outlook for Italy’s economic growth strengthens the view that the budget deficit will significantly over-shoot the government’s targets.”

“We expect the budget deficit to be considerably higher than projected, at close to 3% GDP in 2019 and 2020. Given this, we remain of the view that the government debt ratio will trend up in the coming years, in contrast to the government’s expectation that it will decline.”

“Against this background, we are cautious on Italy’s government bonds at current levels. Our base case is that the 10Y spread between Italy’s government bond yield and that of their German counterparts will rise to around 275bp (compared to 260bp at time of writing).”