GS: European Economics Analyst - FJElite

Since the onset of the Middle East conflict, Italian sovereign bonds have led the widening in Euro area spreads. While the labour market remains tight, with the employment rate at record highs, further gains should be limited and macro momentum is weakening. We expect growth to slow further as the energy shock feeds through, with recession risks rising materially should the conflict persist into the second half of April.

Markets are increasingly pricing weaker European growth into Italian spreads, with attention now shifting towards country-specific risks. In our view, two factors are key for the Italian outlook: the scale of the fiscal response to the energy crisis and rising political risk that could jeopardize the final disbursements and implementation of the European Recovery Fund.

A sizeable, potentially 2022-like fiscal response would materially worsen debt dynamics, lifting the debt-to-GDP ratio by almost 3pp by 2028 on our estimates. However, political appetite for aggressive fiscal easing appears limited, and we would expect a meaningful shift only if the energy shock extends beyond April. Moreover, a severe but temporary energy shock tends to boost nominal growth, partially offsetting higher borrowing costs and mitigating debt sustainability concerns, as observed after the 2022 crisis.