There are two classic reasons for a rapid rise in sovereign yields - a solvency or a liquidity problem. Italy's situation is less clear cut: solvency depends on a combination of interest rates, the growth outlook and the gap between taxes and expenditure (net of interest payments).

Assuming Italy maintains a large primary surplus (as factored in the current Budget law), Italian yields could even rise to double digit figures for a couple of years before its interest payments as a share of GDP became unsustainable.

However, this requires strong political commitment. Any retrenchment of the fiscal effort would put Italy in a difficult position. Against this background, the instability of Italy's political situation could increase market anxiety levels before rates got even close to double digits, and at 7% or 8% Italy could find it was unable to raise sufficient money on the bond market. In short, a confidence issue could turn into a liquidity issue.


source: Bank of America ML