Italy's growth is slowing, not stalling, while fiscal and political risks are rising but not yet out of control

Overview

This report focuses on Italy's macro and sovereign-bond risks after the Middle East conflict and the resulting energy shock. Goldman Sachs believes Italy's economic momentum is weakening. Although the labor market remains strong and the employment rate is at record highs, further room for improvement is limited. Markets have already priced Europe's weaker growth into Italian sovereign spreads, and investors are beginning to focus on country-specific risks such as fiscal response and political stability.

Core views

The core judgment is: growth is slowing, not stalling; fiscal risk is increasing, not breaking down. The report cuts Italy's 2026 and 2027 GDP growth forecasts, but believes the recent widening in BTP spreads mostly reflects Europe-wide growth concerns rather than a loss of control over domestic Italian risk. On the fiscal side, a short-term energy shock may lift nominal growth and partially offset higher financing costs; the real sustainability risk comes from large discretionary fiscal loosening. Politically, although the failure of the constitutional referendum raised concern about early elections, the base case remains that the Meloni government continues and carries through on Recovery Fund implementation.

Analysis framework

The report combines macro forecast revisions, financial-market pricing, fiscal sustainability, and political-risk analysis. Growth analysis tracks momentum using consumer confidence, high-frequency indicators, and GDP trackers; market analysis uses a sign-constrained structural vector autoregression model to separate Europe-wide shocks, domestic risk, and rate sell-offs behind the BTP-Bund spread; fiscal analysis evaluates energy-related fiscal responses, nominal growth, effective debt costs, and the debt-ratio path; political analysis centers on remaining Recovery Fund disbursements, government incentives to stay in office, and early-election risk.

Methodology notes

• Macro forecastGDP forecast revisions and high-frequency activity indicators

  Uses consumer confidence, GDP trackers, energy prices, financial conditions, and changes in global growth forecasts to assess Italy's growth momentum.

  Assuming the Middle East conflict lasts until mid-April, the report cuts Italy's 2026 and 2027 GDP growth rates and estimates the cumulative drag from energy, financial conditions, and external demand on GDP over the next three quarters.

• Rates and sovereign bond analysisSign-constrained SVAR model

  Separates Europe-wide shocks, domestic Italian risk, and rate sell-offs by looking at changes in Italian and German yield curves and the 10-year BTP-Bund spread.

  The model shows that the recent widening in spreads has been accompanied more by flattening in the Italian and German curves, pointing to rising European growth concerns rather than a meaningful deterioration in domestic Italian risk.

• Debt sustainabilityi-g framework

  Compares effective debt costs i with nominal growth g to judge the actual sovereign financing pressure during the energy shock.

  The report argues that a temporary energy shock may lift nominal growth, easing some debt sustainability pressure; however, if the government responds with large-scale fiscal support similar to 2022, the debt-ratio path would deteriorate materially.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• BTPs

  Italian sovereign bonds are the main market expression discussed in the report.

  Strengths

  In the base case, government continuity and Recovery Fund execution are likely to remain intact, domestic risk remains contained, and BTPs can serve as a relatively resilient carry expression.

  Weaknesses

  Italy is more exposed than peers to rising energy prices, growth forecasts have been cut, and spreads have already widened ahead of other European sovereign bonds.

  Comparison

  The report compares Italy with German Bunds and other euro-area sovereign bonds, arguing that spread moves currently reflect European growth concerns more than any single Italian political or fiscal risk.

  Risks

  An extended energy shock, a large fiscal response similar to 2022, early elections, and delays in Recovery Fund disbursement and implementation.

• 10y BTP-Bund spread

  Used to measure Italy's sovereign credit risk premium relative to Germany.

  Strengths

  The SVAR decomposition shows that domestic risk factors remain relatively contained.

  Weaknesses

  Markets have already priced weaker European growth into Italian spreads, and if country-specific risk rises, spreads could come under further pressure.

  Comparison

  Used together with the German yield curve to separate Europe-wide shocks, domestic risk, and rate sell-offs.

  Risks

  A flattening domestic curve together with wider spreads would point to rising Italy-specific risk.

Key data

• Italy GDP growth forecast0.5% in 2026, 0.6% in 2027Previous forecasts were 0.9% in both years.
• Change in financial conditionsTightened by about 30bpSince the Middle East conflict began.
• Change in energy pricesAverage increase of about 30%The energy shock is an important source of the growth downgrade.
• Change in global growth forecastDown by 0.6 percentage points over the next yearWeaker external demand and financial conditions are jointly weighing on Italy's activity.
• Estimated GDP drag over the next three quartersAbout 0.8%Assumes the conflict does not end quickly and oil and gas flows do not return to pre-conflict levels within 30-45 days.
• 2026 primary fiscal balance forecast1.0% of GDPPrevious forecast was 1.3%.
• Potential impact of fiscal easingDebt ratio up by nearly 3 percentage points by 2028Based on energy-related fiscal measures similar to 2022, at about 1.5% of GDP.
• Remaining Recovery Fund disbursementsMore than EUR 40 billion, about 21% of the planned total, or roughly 2% of GDPStill available in 2026; around EUR 80 billion of spending can be deployed in 2026 and early 2027.
• Growth impact if Recovery Fund execution is disrupted2026 growth impulse could fall from +0.1 percentage points to -0.3 percentage pointsScenario assumes government interruption and election activity affect the execution of the remaining plan.

Impact & implications

For investors, the message is that risks are rising but have not yet evolved into an Italy-specific crisis. If the energy shock remains contained, Italy's macro fundamentals, together with relatively low fiscal and political risk, still support BTPs as a relatively resilient carry expression; if the conflict lasts beyond April and triggers more aggressive fiscal loosening, BTP spreads and debt sustainability pressure could rise materially.

Risks

• The Middle East conflict lasts until late April or longer, extending the energy shock.
• Oil and gas flows fail to return to pre-conflict levels within 30-45 days.
• The government introduces a large-scale energy fiscal subsidy package similar to 2022, worsening the debt-ratio path.
• Political momentum weakens further after the failed constitutional referendum, triggering early elections or a government interruption.
• Remaining Recovery Fund disbursements and investment project execution are delayed.
• Concerns about European growth intensify further and push the BTP-Bund spread wider.

What to watch

• Whether the Middle East conflict eases around mid-April and whether energy prices fall back.
• Whether the Italian Treasury maintains its guidance that fiscal space has been exhausted.
• Italy's 2026 Recovery Fund disbursement pace and the execution of around EUR 80 billion of project spending.
• Whether consumer confidence, GDP tracker readings, and labor-market data continue to weaken.
• Changes in the 10-year BTP-Bund spread and the shape of the Italian and German yield curves.
• Polls and political news on the stability of PM Meloni's government and the probability of early elections.