Italian politics sparked market turbulence this week. After President Mattarella vetoed on the appointment of euro-sceptical Paolo Savona as minister of finance, markets were in disarray. Later, parties have proposed a new minister of finance and a new government can be established.
Italian bonds reacted strongly to these developments, as investors feared a revival of the discussion about the future of the euro and a potential write-off on Italian bonds. Italian 10-year yields rose above 3% on Tuesday. The fear was that Italian banks would tumble over, as they hold large portions of Italian government debt. This caused default risk premia for most corporate bonds to increase, and prices to fall.
Over the last few days, markets have quietened down somewhat, and the Italian 10-year bond yield now fluctuates around 2.6%. We, however, expect volatility in these parts of the bond market to persist, until there is more clarity on the impact of Italy's political woes.
During all the turbulence, we also saw a first glimpse of eurozone inflation rising towards 2% in May. This is mostly related to energy prices, but also core inflation. On the core inflation front, however, we do not expect these effects to pull through. We expect core inflation to more or less remain at current levels for the next few months. Although the political developments in Italy have completely overtaken the price development of German and Dutch government bonds, part of the recent rise in yields should also come from this inflation development.