The slow-motion confrontation with the EU Commission will drag on well into next year. Higher cost of funding and higher taxes for banks next year will hurt credit. Lack of contagion means Italy is the only major EA “peripheral” country left.
More debt and no growth. A wealth tax on property, levies on bank deposits and a serious spending review are political non-starters. So, we expect S&P to change Italy’s outlook to negative on Friday in anticipation of a downgrade (together with Fitch) in Q1 next year, which is already priced in. We also stick to our view that the fiscal multipliers for Italy are very small, if not zero. Any stimulus from the budget (estimated at around 0.2% of GDP) will be offset by deteriorating credit conditions for households and firms.
More importantly, however, the definition of the EA periphery seems to have changed. Spain and Portugal have come a long way since the EA debt crisis. Not only have they addressed their pressing structural problems, but they have also caught up on growth. With the exception of Greece, a special case, Italy remains the only true EA laggard. We don’t think the ECB will do anything in the short run that could be seen as a favour to Rome, but in the long term the continued divergence of Italy (especially vis-à-vis Germany) will be the greatest challenge facing the EA and its central bank.
S&P downgraded their outlook to negative in October 2018. In Q1 2019 the ECB was pushed into action to introduce a new round of TLTRO's primarily to support the Italian banking system.