Italian co-Deputy Prime Minister Luigi Di Maio got what he wanted when the broad outline of the government was made public last weekend. The budget included the M5S’ ‘citizen’s income,’ a new spending initiative intended to ease the burden of low-income families. The budget also included income tax breaks championed by the League and plans to enable early retirement for hundreds of thousands of workers.

The inclusions carry a high fiscal cost, and Italy upped its budget deficit target for 2019 to 2.4%. The final number will likely come in higher; Rome has undershot its own deficit targets for both 2017 and (likely) 2018 as well.

The new budget has had two immediate impacts: 1) it has sent bond markets into a frenzy; and 2) it has set the stage for a high-profile clash with Brussels.

Impact

Bond traders head for the exits. Italian yields have soared since the budget guidelines were made public, with 10-year bonds hitting 3.44% before falling back to 3.36% on Tuesday. The steep increases since last week (the 10-year closed at 2.91% on Friday) reflect the sense of compliancy that had settled over bond traders in the lead-up to the budget disclosure. Many had believed that Finance Minister Giovanni Tria would be able to impose a more austere spending outlook on the governing coalition.

Yields received another jolt on Tuesday when Claudio Borghi, a top economic official in the League, went on record stating that most of Italy’s problems could be solved by bringing back the lira. Borghi’s comments have since been walked back by Prime Minister Conte, who offered reassurances that Italy has no intention of leaving the euro zone.

The overriding takeaway from the 2.4% budget target is that Italy will not be taking steps to reduce its public debt over the short-term. In a best-case scenario, the debt will remain stable. However, it’s far more likely that any combination of lackluster growth, a toxic debt-saddled financial system, and/or an external shock will see Italy’s debt increase under the coalition’s watch. Even the speculatory yield spikes of the past week can add up quickly and translate into significant new borrowing burdens for the Italian government.