As a populist-led government takes power in...>

ITALY: As a populist-led government takes power in Rome, the absolute yield on

Italian debt - not just the spread vs Bunds - will test fiscal sustainability.

- While spreads are obviously important, the 3 key risks are higher absolute

yields, a narrower primary budget surplus, and slower growth. 

- At the height of the May crisis, the 10Y BTP spread over Bunds rose by 204bps,

but BTP yields levels rose relatively less: 168bps. Though they hit 2014 levels

at 3.44%, BTPs came back (now 2.65%) - not unsustainable territory...yet.

- A senior Bank of Italy source told MNI in exclusive comments in May that

Italy`s long maturity profile means even if the rates on new bonds increased by

2pp (implying well above 3.0%), debt service costs could remain steady.

- Consistent with this, OECD sees the overall rate on Italian long-term debt at

2.2% in 2017, 2.4% in 2018 and 2.6% in 2019, with interest payments dropping, a

steady primary budget surplus, and debt as % of GDP falling from 132% to 128%.

- Current yields suggest sustainability for now, but Lega/M5S fiscal plans

would, unaltered, lead to a worsening primary balance and/or a debt crisis. And

spreads are unlikely to fall to earlier levels, reducing the margin for error.