>> GROUP: Shadow ECB Council / EZB-Schattenrat  Dr. Elga Bartsch

Dr. Elga Bartsch: The formation of a populist coalition government in Italy intensifies European political risks and heralds the return of elevated country risk premia within the euro area. While the appointment of a more moderate finance minister than markets previously feared temporarily calmed markets, we expect more confrontation between Italy and the EU ahead over the 2019 budget.

The decline in the Italian manufacturing PMI in August stands out versus its peers. Hence it seems that prospects of a confrontation with the EU are already having an impact on sentiment in Italy itself. On balance, we expect the impact on the euro area growth and inflation outlook to be limited. While growth momentum across the euro area had slowed in H1 2018, there are some encouraging signs of improvement more recently, e.g. the Ifo business expectations, or the stabilisation in the euro area composite PMI.

Thus far, the contagion from the turbulence in the Italian government bond market into other peripheral markets has been very limited. As a result, overall financial conditions in the euro area have remained supportive. As a result, the ECB should continue with the plan to wind down its net purchases, focus on defining its reinvestment strategy, and gradually prepare markets for a first depo rate hike in the autumn of 2019.
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