France’s fiscal crisis is spilling over into Italy

 It will not, at least one hopes, have the same effect as Greece’s default, which triggered the sovereign debt crisis in Europe, but France’s fiscal crisis is beginning to show signs of spreading beyond its borders. Italy is the country showing the first symptoms, with the spread having risen above 100 basis points once again and, above all, a yield that has reached 4.6 per cent. The 10-year BTP is performing relatively better than the French OAT, which historically had a lower yield but is now around 20 basis points higher than the Italian bond. 

But the problem – the warning sign for Italy – is that they are now acting in unison. And this is a new development. In 2025, government bond yields rose across all eurozone countries, due to a number of factors including the announcement of Germany’s defence spending plan, which triggered a rise in Bund yields and put upward pressure on other government bonds. In this context, Italy represented a positive anomaly. Although it has a high level of public debt, it was the only country to have kept BTP yields broadly at the same level as in 2024, resulting in a narrowing of the spread. The credit for this went entirely to fiscal consolidation, which, at a critical moment, stabilised public finances by bringing the deficit down to 3.1 per cent.

In 2026, however, things are taking a different turn. The trend in Italian government bonds has mirrored that of French bonds: yields have risen by around 100 basis points over the last three months, with the spread widening by around 30 points. But whilst this trend is understandable for France – which has a deficit spiralling out of control (5.4 per cent in 2026, exceeding the forecast of 5 per cent) and debt rising to 119 per cent, with a government unable to balance the books – it is less so for Italy, which continues to pursue a ‘prudent’ fiscal policy (as Giorgetti describes it), which this year is expected to bring the deficit back below 3 per cent. So why are BTPs being affected by the French contagion?

Compared with a few years ago, when the deficit stood at 8.2 per cent, the trend in Italian debt appears more sustainable: rating agencies have upgraded the country’s credit rating, Italian banks and domestic savers have absorbed a large proportion of bond issues, and the share held by foreign investors is not particularly high. However, this greater stability is not enough to prevent contagion. Indeed, according to some analysts, it has created a vulnerability. Because with domestic investors already holding very large stakes, foreign investors have become more important as marginal buyers; however, unlike their Italian counterparts, they are more cautious and less inclined to take risks during periods of turbulence. Consequently, BTPs are sensitive to shocks originating from other major European bond markets, as is currently the case with the French market.

But what does this mean for the real economy and public finances? In last year’s Public Finance Policy Document (DPFP), the Ministry of Economy and Finance (MEF) had drawn up a number of risk scenarios with their respective macroeconomic impacts. One of these scenarios assumed tension in the financial markets, with BTP yields from 2026 to 2028 more than 100 basis points higher than in the baseline scenario. This is roughly the increase that has actually occurred compared with October 2025, when the DPFP was published. According to the MEF, this scenario of a sustained rise in interest rates would have a negative impact on growth of -0.1 percentage points of GDP in 2026, -0.5 in 2027 and -0.6 in 2028. The increase in interest expenditure under this scenario – with the cost of debt rising by 100 basis points – is quantified, according to the MEF’s latest calculations, at +0.13 per cent of GDP in 2026, +0.30 per cent in 2027 and +0.45 per cent in 2028.

The impact is not significant for this year, given that the rise in inflation and growth (from 0.6 to 1 per cent) should enable the government to keep the deficit below 3 per cent. However, if the rise in interest rates were to persist over time, interest expenditure – which was forecast at 4.2 per cent in 2027 – would rise to 4.5 per cent, and in 2028 it would increase from 4.4 to 4.9 per cent of GDP. In practice, the rise in interest expenditure would eat up the entire projected increase in the primary surplus, making it increasingly difficult to stabilise public debt.

Regardless of how the French fiscal crisis unfolds, as Guido Ascari and Riccardo Trezzi pointed out in yesterday’s edition of Il Foglio, high inflation and public deficits worldwide are ushering us into a new regime characterised by higher interest rates. It would be wise for the coalitions standing in the forthcoming general election to adapt their government programmes to this shift in the macroeconomic regime.

Luciano Capone