The decline in the spread is not only positive for public accounts, but for the entire Italian economy. Let’s see why.
Only on November 7, the day after Donald Trump’s clear victory in the US elections, 10-year BTPs offered a premium of around 135 basis points or 1.35% over Bunds. The market was sensing the risk of a slowdown in interest rate cuts by the European Central Bank (ECB).
Since then, however, this feeling has had to deal with the progressive deterioration of macroeconomic conditions in the Eurozone. And last Friday, Italy’s spread was falling to a minimum of 105 points or 1.05%. We have fallen to the lowest levels in over three years.
Towards a maxi-cut in ECB rates
The yield on the 10-year BTP is now below 3.20%, the lowest level since August 2022. A drop of more than half a percentage point in just one month.
Investors are pricing in a major rate cut in December, that is, next week. The ECB is expected to reduce the cost of money from 3.25% to 2.75% (rate on bank deposits). But the drop in the spread signals that the credit risk perceived by the market regarding Italian public debt is also contracting.
This is undoubtedly a positive fact for the state accounts. Falling yields reduce the costs of issuance, so the new debt will weigh less on the pockets of all of us taxpayers. But what we rarely talk about is that the fall in the spread is good for the entire Italian economy, not just for public budgets.
Sovereign yields are a sort of “benchmark” for the structure of market rates. In practice, when a bank has to set the rate on a loan, it takes into account the “risk free” yield that it would obtain simply by lending money to the state. And those who resort to the market in search of liquidity (banks, companies, etc.) must take into account the yields offered by the state to attract demand.
Entire rate structure down
The higher the yields along the interest rate curve , the higher the interest required from businesses and families. And savers, for their part, will also demand more. Look at the deposit accounts in recent years with the increase in rates.
With the consequence that, when the spread with Germany, France and other states is high, the costs for investments and purchases of durable goods also become relatively higher. In short, Italy does not only have a problem of state interest expenditure, but also of higher costs for doing business and for financing family purchases.
The fall in the spread reduces this gap and tends to favor the private economy. The distances between Italy and Germany, but also with the other countries of the Eurozone, are shortening. Investing in the Bel Paese becomes relatively less expensive and so does taking out a mortgage or financing.
This will stimulate aggregate domestic demand over the months . We require it, assuming it is accurate to say that Istat has cut its GDP growth prediction . In half for this year to 0.5% and for next year to a still-poor 0.8%. Domestic demand itself, explains the institute, will make a negative contribution of 0.2% in 2024.
Possible virtuous circle from drop in spread
Just as vicious circles are sometimes triggered, virtuous ones can also originate from a favorable trend. The decline in the spread may push rating agencies to promote BTPs in the coming months.https://youtu.be/bIYtyEeEJ4U?si=PkD-o-Iw1oMVIxgP
In turn, these moves would further reduce the gap with German yields, supporting both the good mood on the markets and economic growth through domestic demand. But nothing comes from nothing. Italy will have to show itself capable of pursuing a prudent fiscal policy . And at the same time strengthening growth prospects with micro-reforms that may be cost-free but have an impact. The political and financial convulsions in france come to the rescue, shifting attention to Paris, while the spotlight on Rome is fading after years.