ROME — While all eyes are on the looming fight between the European Commission and France over EU spending rules, another high roller may soon be in for a shock of its own.

Since taking office in 2022, Italian Prime Minister Giorgia Meloni has defied expectations of populist excess with her largely undramatic stewardship of the Italian economy.

That has earned her the respect of the EU establishment and international markets, but her efforts may soon be undone: Market unease over the prospect of political breakdown in France is already spreading to Italy, and the Italian political establishment is growing nervous. 

In the turbulent two weeks since French President Emmanuel Macron dissolved parliament after a drubbing from right-wing hardliner Marine Le Pen in the June 9 European election, the risk premium on Italian debt has increased considerably: The "spread" between the benchmark 10-year Italian and German bond yields has widened 0.20 percentage points. 

While it’s still a full percentage point narrower than it was when Meloni took office, it’s a reminder that the confidence of investors is never something she can take for granted. 

Italy’s borrowing costs are consequently rising just as the EU's campaign for budget deficit reduction is intensifying. Earlier in the month, the European Commission rebuked seven EU countries — including France and Italy — saying that so-called “excessive deficit procedures” requiring them to undergo major debt reductions were warranted. 

That means market skepticism toward the Italian economy, with its chronic low growth and heavy public debt burden, could upend Meloni's careful economic balancing act designed to appease both the voters and Brussels. 

With right-wing and nationalist parties strengthened in the European election and expected to surge in France, investors see the continuation of European economic solidarity policies — which countries like Italy have depended on during economic shocks — as less likely in the future. 

The question is whether Meloni will be able to capitalize on existing goodwill to ride out any turmoil — or be forced to abandon key pledges on taxes and spending.

Restraining order

Why has Meloni — a once-strident Euroskeptic populist whose Brothers of Italy party traces its origins to the post-war remnants of Benito Mussolini’s fascists — been so popular with financial markets?

As HSBC Senior Europe Analyst Fabio Balboni told POLITICO, Meloni learned from the mistakes of her far-right predecessor Matteo Salvini, who was interior minister under Giuseppe Conte in 2018. Salvini unleashed market chaos by insisting on a budget which openly defied the EU’s fiscal rules, and which was rejected outright by the Commission, leading to internal feuding back in Rome and, ultimately, to the collapse of the government. 

By contrast, Meloni has cooperated with Brussels rulemakers while supporting an Atlanticist, pro-NATO foreign policy, even if she remains a covert hardliner at home.

That cooperation has built her goodwill with both EU institutions (ensuring that nearly €200 billion of Next Generation EU funds to boost the economy after Covid was earmarked for Italy) and financial markets. One European Central Bank official, speaking on condition of anonymity, argued that, unlike Le Pen, the Italian leader had become a genuine moderate, predicting that she will likely stick with the fiscal rules. 

“She would squander a lot of her new political capital” if she didn’t, agreed Davide Oneglia, senior economist at consultancy TS Lombard in London. 

The turbulence in French markets has given Meloni a powerful incentive to play up this reputation, and her government is already full of assurances that it will be compliant.

"We intend to respect [fiscal pledges] absolutely," Economy and Finance Minister Giancarlo Giorgetti said last week in response to the EU’s move. 

Two EU officials in close contact with the Meloni government told POLITICO there was little sign of Rome planning to push back against the rules, arguing that doing so would be foolhardy. 

Or, as one former Treasury official put it: “They’re gripped by  terror.”

Super-onerous 

At the same time, good intentions may not be enough. 

As Balboni noted, Italy’s sovereign debt pile, the largest in Europe at over €2.9 trillion, makes it vulnerable to any European market panic, no matter how tight it’s been with its purse-strings. 

“We may argue the markets are unfair, but it’s useless,” said Carlo Cottarelli, a former Italian senator and senior IMF official who now directs the economic and social sciences program at the Catholic University of Milan. “It’s a fact of life when there is a shock to the EU economy, given our public debt. Even if it’s not fair.”

But the truth is that Italy’s economy has many vulnerabilities, including chronically low growth, an ageing population, and intrusive regulation overseen by a hidebound bureaucracy.  

Perhaps the most glaring open wound is the so-called Superbonus, a tax incentive for home renovations that helped swell Rome’s deficit to 7.4 percent of GDP last year. 

Rome has made a point of blaming the deficit on that policy alone, but that’s stretching a point. Oneglia argues that Italy still hasn’t embraced serious reform and is doing only the bare minimum to avoid economic embarrassment. With additional scrutiny, he said, markets might start to cotton on. 

If they do, then rising interest costs could force Meloni into unpopular measures, such as reversing a €12 billion cut in labor taxes that also contributed to last year’s deficit.

Much will hinge on whether Giorgetti can secure concessions when he presents his plans for shrinking the deficit to the Commission at the end of summer.  

It also hinges on what attitude the EU and the new French government take to each other. The EU has historically indulged France, especially on budget issues, and especially when it was not alone in sinning. That might encourage Meloni to deviate from the rules herself, suggested Oneglia.

But that’s a long shot. From painful experience, Rome knows better than most that it’s the financial markets, not the EU, that ultimately keep free-spending governments in check.  

“You can discuss with the Commission,” said Cottarelli. “But you cannot discuss with the markets.”