As expected, the initial market reaction to the EUCO summit (see our review here) is very negative. This morning, Italy-Germany 10 year bond spread opened wider, and it is testing at the moment of writing this note 250bp yield spread, which represents a price differential of about 38bp over the past few days. Tonight, S&P will release its rating review for Italy, and a rating cut is widely anticipated.

In the coming weeks, the BTP market, which is, in our view, the best proxy to assess the level of confidence in the EU, will remain in the spotlight. Moody will update its rating, currently on lowest investment grade notch, on May 8. Also, there is a huge inflow of BTP issuance coming in an already saturated market. All of this will increase the pressure significantly on the BTP market.

While the EU is stalled due to lengthy deliberation, the ECB is likely to stay the only game in town to counter an increase in peripheral spreads. If the situation further deteriorates, it may force the ECB to intervene in a timely manner in order to expand the size of its PEPP programme that runs until the end of the year.

Best regards.