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Italy-Germany bond spread meets highest level since 2013 over EU budget dispute

The spread between exchanges of Italian and German bonds climbed to the highest level of almost five years on Friday…

The spread between exchanges of Italian and German bonds climbed to the highest level of almost five years on Friday as a line between Rome and Brussels over the country’s budget is threatening to boil over.

The European Union’s authorities on Thursday rejected budget proposals made by Italy earlier this week, accusing the euro area’s third largest economy of an “unprecedented” breach of EU rules on spending and deficit limits.

In view of Italy’s plans to increase spending and its deficits and to keep the sovereign debt remain elevated, the European Commission said the country is trying to implement “a particularly serious” violation of the rules.

“These three factors seem to point to a particularly serious failure to comply with the budgetary policy obligations laid down in the Stability and Growth Pact,” said a letter to Italian finance minister Giovanni Tria, who appeared late on Thursday.

“With Italy’s sovereign debt, which accounts for around 1

30% of GDP, our preliminary assessment also shows that Italy’s plans would not ensure compliance with the debt criterion,” it continued.

The agitation has increased tensions between the two parties, with a confrontation that looks more and more likely. The potential result has shaken investors, spreading the spread between Italian and German 10-year bonds to its highest since 2013 at the end of the euro area debt crisis.

On Friday morning, the spread was 3.4 percentage points, an increase of close to 50% compared with the levels at the end of September.

The table below illustrates the scale of the latest increase in spread:

Germany’s government debt is generally seen as one of the safest investment vehicles on the planet thanks to its strong commitment to to drive a budget surplus. On the other hand, Italy looks smaller and less stable, leading to higher bond yields.

For the context, the budget proposes to increase both Italy’s total sovereign debt and its short-term deficit and push the deficit as high as 2.4% of GDP in the next few years. This means that Italy will fall in error with an earlier mandate with the highest deficit of 0.8% of GDP.

Italy was asked to change its budget by the euro area authorities before it was sent in and was told that the proposals constitute “significant deviation” from its mandate. It refused to do so, with the Italian parliament to vote to approve the proposals on Monday evening.

Matteo Salvini, leader of the Northern League, one of the two coalition partners in the Italian government, has clarified that the government is planning to continue with the implementation of its budget proposals, regardless of resistance from Brussels.

“If Brussels says I can not do that, I do not care, I’ll do that anyway,” said Salvini last week, referring to the implementation of the budget.

Italy has until Monday to respond to the Commission’s conclusions.

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