In recent weeks, turmoil in French debt has brought European fiscal pressures into the spotlight, but as a controversial new government spending plan is introduced, investors' attention is rapidly shifting to Italy.

Goldman Sachs analysts say the Italian government will submit its budget next week, which includes recently approved defense and energy allocations. This will widen the country's deficit over the next two years and put Italy's debt-to-GDP ratio on track to become the highest in Europe.

Goldman Sachs senior European economist Filippo Taddei said these changes could put further pressure on Italian government bonds before next year's general election.

On October 2, Prime Minister Giorgia Meloni's center-right government approved an additional 28 billion euros ($31 billion) in borrowing over the next two years for defense and energy spending. Despite the scaled-back size, these spending plans still raise Italy's 2027 deficit target to 3.4% of GDP and the 2028 target to 3.2%, higher than the 2.8% and 2.5% forecast earlier in April and above Goldman Sachs' projections.

The measures are split evenly between defense and energy, each accounting for roughly 0.3% of GDP per year in 2027 and 2028.

This comes as investor concerns about out-of-control government borrowing across the continent are intensifying.

French Bond Troubles

In recent days, French government bond yields have surged to multi-year highs, and the country's escalating debt crisis has triggered broader worries about Europe's strained public finances. The French benchmark 10-year OAT yield fell 3 basis points to 4.85% on Friday as oil prices declined. The 10-year Italian BTP yield was last down 5 basis points at 4.55%. As of 1:40 p.m. Central European Time (7:40 a.m. Eastern Time), the spread between the 10-year German bund — the eurozone debt benchmark — and the Italian BTP was about 108 basis points.

Taddei said that against the backdrop of an expanded deficit, Italy's fiscal risk premium could rise before the country's next general election. The next election is due by December 22, 2027 at the latest. He explained that a close election could leave little room for fiscal consolidation, as both left-wing and right-wing parties want to "bring in spending-friendly partners" to build a viable coalition. In a report on Thursday, he said: "Looser fiscal policy, tighter financial conditions and a close election appear set to weaken the debt outlook after four years of fiscal consolidation."

A "Major Upside Surprise"

Italian lawmakers voted on Thursday to reform the country's electoral process, shifting from a mixed model to a more proportional representation system. Meloni's right-wing coalition says the change will bring more stable government and avoid messy post-election bargaining. But left-wing opponents say the changes are designed to help Meloni stay in power. The Meloni government — which will submit its last pre-election budget next week — has been praised for reducing the deficit, which reached 3.1% in 2025. The bond market in turn rewarded the country's newly gained political stability, and Meloni recently became Italy's longest-serving leader since World War II.

These spending increases are in line with the EU's "national escape clause," which allows member states temporary fiscal flexibility for defense and energy investment to cope with shocks caused by the Russia-Ukraine war and Middle East conflicts. However, Taddei said the new deficit targets are "a major upside surprise."

Taddei noted: "We find that a higher fiscal deficit combined with rising yields appears set to put the debt-to-GDP ratio on an upward trajectory until 2028, then stabilizing at around 137% — which would be the highest in Europe at that time." "In the current environment, higher yields pose a key challenge, and we find that a structural rise in 10-year yields above 4% could push Italy's debt-to-GDP ratio even higher thereafter."