Bond markets are gearing up for a return to political turmoil in Rome after a key investor risk gauge hit its highest level in 16 months ahead of a crucial vote on Italy’s next president.
The difference between yields on Italian and German bonds has widened to its largest since Mario Draghi became prime minister after he became the frontrunner in next week’s presidential race.
The gauge is closely watched as a measure of market concerns over volatile Italian politics as fears mount that far-right parties could win power in snap elections.
Italy’s parliament will decide on a new president on January 24, but investors fear Mr Draghi’s plans to jolt the economy from a decades-long stagnation will suffer if he switches roles.
Italian borrowing costs have risen in recent weeks amid fears that Mr Draghi’s exit would trigger early elections ushering in the far-right Brothers of Italy and Lega.
Italy’s 10-year bond yield has risen from 0.91pc to 1.35pc in the past month as government borrowing costs climb across the world.
Lorenzo Codogno, a former chief economist of the Italian Treasury and founder of LC Macro Advisors, said “some of the reforms would definitely be at risk” if the right came to power, particularly plans to shake up welfare and pensions.
“We have seen in the past that financial markets are very sensitive to political developments, especially if [they] lead to a government that might be less committed to Europe, less committed to reforms,” he said.
Italy’s president holds a ceremonial role that becomes crucial in times of political strife, acting as a referee in Rome. The highly popular Mr Draghi, a former European Central Bank president, and former prime minister Silvio Berlusconi are considered the most likely candidates for the secret ballot.
Jack Allen-Reynolds at Capital Economics said a new election that resulted in a new government would put the plan at risk.
“A new government might also have different priorities that don’t necessarily align with the current recovery plan. Whichever new government it is has the incentive to play ball on the recovery plan,” he said.
“The sums of money available are huge and if Italy doesn’t pass the reforms, it doesn’t get the money.”
Brothers of Italy and Matteo Salvini’s Lega are vying with the centre-left Democratic Party for the top spot in polls as speculation of snap elections builds.