The bond market in Italy may be the most affected by Europe's stalemate on fiscal reform.

• As a Europe-wide election approaches, there is increasing pressure on finance ministers to reach a deal in the near future.
• Italian bonds have been under pressure lately.
• Despite Rome's budgetary plans for 2024, the markets were not satisfied with the global concerns of higher interest rates lasting longer than anticipated.

The European Union's standoff over new debt rules could lead to additional economic pressure for Italy.

Disagreements among the 27 member states of the EU over new debt rules have prolonged discussions aimed at simplifying government finance correction for several months.

As a Europe-wide election approaches, there is increasing pressure on finance ministers to reach a deal in the near future.

The risk of a "no deal" is increasing as time runs out, potentially harming the euro and reigniting fragmentation fears in the EGB market, according to Davide Oneglia, director of European and global macro at TS Lombard, in a note last week.

Italy could lead potential bond market shifts, as he stated.

The prospect of a return to strict fiscal rules and a faster deficit reduction would negatively impact the EU's medium-term growth prospects, causing concern about the euro and introducing fear of fragmentation for peripheral, particularly Italian, bonds during a time of economic slowdown, monetary tightening, and a challenging global market environment, according to Oneglia.

Rome's budgetary plans for 2024 have added to the pressure on Italian bonds, as global concerns about higher interest rates persist.

Giorgia Meloni's government reduced its economic growth forecasts for this year and the next, and raised its budget deficit targets. As a result, the yield on the 10-year bond rose and hovered around 5% in the following days. The bond traded at 4.76% at about 5.30am London time on Wednesday.

Analysts at Goldman Sachs predict that the negotiations on fiscal rules will likely be postponed until the second half of next year due to the upcoming European elections.

The old rules

The European Commission, which oversees fiscal rules, has not consistently enforced or complied with the rules requiring member states to maintain a 60% debt-to-GDP threshold and a public deficit of 3%.

In 2020, the fiscal rulebook was frozen to allow member states to deviate from their fiscal targets and spend on pandemic-related matters. Similarly, in 2022, the fiscal rules were kept on hold due to Russia's invasion of Ukraine, which resulted in new energy costs and inflationary pressures. The suspension of those rules will end in December.

In 2024, European nations will have to follow the rules again, after a three-year suspension and decades of criticism. However, there is pressure to reform the rules in 2025, but the political calendar for next year may get in the way.

If there is no agreement on new rules, as it seems likely, the existing rules, currently suspended, would kick in in 2025. These rules are stricter than whatever is being discussed now, according to Moritz Kraemer, chief economist at LBBW, who told CNBC.

In principle, stricter rules would force Italy to follow a tougher fiscal position, resulting in less bond market volatility.

The enforcement of stricter old rules for Italy and other European nations is uncertain, despite the possibility of their implementation.

Goldman Sachs analysts stated that it is unlikely that the EU Commission will initiate an excessive deficit procedure against any member country before the negotiation on the fiscal rules is finished.

A watchlist of countries that are not correcting their finances at the required pace is created by an excessive deficit.

The Belgian presidency in the first quarter of 2024 is more likely to see a compromise on fiscal rules, with the real deadline being the end of March, allowing the legal text to go before the European Parliament before the June 2024 elections, according to Didier Borowski, head of macro policy research at the Amundi Investment Institute.