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Analysts at Wells Fargo, explain that Italian policymakers have continued full steam ahead with their plans to ease fiscal policy next year and they think an eventual compromise will occur before financial penalties are imposed.

Key Quotes:  

“Italian policymakers have continued full steam ahead with their plans to ease fiscal policy next year through a combination of tax cuts and increased spending.”

“EU officials have remained unsatisfied. In a report issued on November 21, the European Commission took another step toward an excessive deficit procedure (EDP) against Italy. In short, the report showed that EU officials remain concerned about the fiscal outlook in Italy, and that they are exhibiting a willingness, at least for now, to use all of the tools at their disposal to enforce fiscal discipline.”  

“It is possible that the European Commission could formally launch the EDP against Italy next week, though sometime in the second half of January/first half of February appears more likely. What would an EDP entail? After the process officially begins, Italy would have either three or six months to correct its fiscal excesses, with the three-month window reserved for particularly serious violations.”

“Were Italy to continue to defy Brussels after this time has elapsed, the country could be subject to a penalty of 0.2% of its GDP (about €3.5 billion), with growing penalties over time possible in the face of continued defiance by Rome.”

“We think an eventual compromise will occur before financial penalties are imposed on Italy, though it may take several months before that compromise is reached. It also strikes us as quite possible that the Italian government could collapse, given the history of instability in Italy and the strain of maintaining a coalition government with a finite degree of fiscal stimulus to parcel out.”

“Even if Italian policymakers thread the needle on fulfilling their campaign promises while avoiding sanctions from Brussels, rising rates in Europe in the years ahead will likely put additional pressure on the sustainability of Italian debt, making future policy choices even more daunting. Furthermore, unless real GDP per capita rises in a meaningful and sustained way, the populist rumblings in the Italian political system are unlikely to completely fade away. Thus, we believe Italian budget drama is likely to periodically come into focus for financial markets for years to come.”