Does Italy have the financial leverage to increase spending? The short answer is (obviously) no.
We have entered a new era of irresponsible spending. A plurality of Europe's populist parties , whether from the extreme left or far right, have more in common than they have differences. What often brings them together is higher public spending, anti-capitalism, Euroscepticism, anti-immigration policy, strong corporatism, and sometimes also regionalism (these elements explain the rapprochement between the League and the Five Star Movement, for instance).
The question is not whether markets are willing to finance a bigger deficit in Italy but at what price. We note that while the country is preparing to blow out its deficit, bond traders care enough to (almost) demand positive yield to own Italian two-year bonds. Based on a conservative scenario (a €75 billion increase in public expenditures, lower PMI, stable inflation, and decreasing GDP growth), debt-to-GDP could reach almost 135% in 2022, whereas the last International Monetary Fund forecast based on continued growth and responsible fiscal policy expects this metric to lower to roughly 107% over the same period of time.
Could Italy really leave the euro area? No, but private investors are starting to freak out and this is bad.
In less than a month, the fear that Italy will leaves the Eurozone has substantially increased. Based on a survey of 1000 investors, Sentix break-up probability jumped to 8.2% for institutional investors – admittedly still far below the levels reached in 2012.
However, the fear of an Italian exit is much higher among private investors, having jumped from 4.8% in April to 14.2% in May.