The yield on Italian 10-year bonds (BTP) was 3.7%. by Tuesday afternoon.

Mounting Pressure

According to Credit Suisse, a 400-basis point spread between Italian and German bonds would signal that the Italian debt is not sustainable, Reuters reports.

Some Italian banks may be forced to seek recapitalization if the Italian bonds they hold in stock lose their value.

In the short term, it is feared that the declining value of government bonds, held by Italian lenders as reserve assets, will affect the markets’ liquidity.

Urging the government to prioritise debt, the Bank of Italy warned on Tuesday that the surging cost on the €400bn required to refinance Italy’s debt could hurt the real economy.

Political defiance

Deputy Prime Minister Matteo Salvini made clear on Tuesday that his government will not backtrack and an expansionary budget is necessary for jobs, growth and investment.

The two leaders of Italy’s governing coalition, Luigi Di Maio and Matteo Salvini have denounced the Commission’s prejudiced view over the Italian budget, which includes tax relief and welfare policies.

In an interview with Corriere della Sera on Sunday, Di Maio set the stage for a European confrontation, projecting that in the forthcoming European elections in May 2019 “there will be such an earthquake in all countries against austerity that the rules will change the day after.”

Striking a different tone, Italy’s Economy Minister Giovanni Tria said that Italy “will do what it must do” to calm markets, the Italian news agency ANSA reports.

However, the 2019 budget deficit target of 2,4% has created set the stage for a confrontation with the European Commission.

The European Commission Vice President, Jyrki Katainen, weighed in on Tuesday making clear the Commission regards Italy’s fiscal targets as “totally unrealistic,” predicting difficult negotiations ahead.

Tria urged for a more constructive discussion and urged Brussels to consider the “well-founded reasons” for this growth strategy, calling the Italian budget targets “prudent.” Tria made clear that Italy must prioritise growth and employment, pointing out that Italy’s GDP is still four points below where it was in 2008.

Tria predicted that Italy’s budget would deliver a drop in the debt-to-GDP ratio of 3% by 2020, as growth will pick up.