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Italian election preview

Background:

Italy will hold a general election on 4th March 2018. Last year this was being identified as one of the big risk events of 2018. Since then, the economic climate has changed dramatically in Italy, which is in turn reducing the risk attached to this political event.

Through most of 2016, Italy’s fragile politics and weak economy was a major concern for the Eurozone and the global economy. Monte di Paschi di Siena was on the brink of collapse, potentially bringing down with it the whole of the Italian banking system. An event which could have led to the downfall of the common currency.

At the same time there was a fear that the failure of then Prime Minister Matteo Renzi to win a referendum for constitutional reforms, could lead to political chaos and a Eurosceptic government which could then threaten the continuation and stability of the euro project.

Ultimately all these fears were overdone. Matteo Renzi stepped down after losing the referendum and was replaced by a technocratic government under the former foreign minister. Italian political risk to the Eurozone project and therefore the euro receded. At the same time the Eurozone economy began an impressive road to recovery, which grabbed the limelight from Italy whilst also helping the country through 2017.

After being out of the spotlight for the past year, Italy is coming back into focus as market participants look towards the election.

Who are the main players?

5 Star Movement – Under the leadership of Luigi Di Maio. It is an anti- establishment and anti -EU movement, although the party has dropped its long-held threat to ditch the euro and has moderated its anti-EU tone, in a bid to increase its popularity heading into these elections. In just 8 years since it started it has become a viable political force. The party refuses to work in a coalition.

Return of Silvio Berlusconi – Four-time prime minister and convicted tax fraudster will return for these elections leading his party the right wing Forza Italia. He remains wildly popular despite the convictions. The party has a coalition agreement with Northern League (Lega Norte) an anti-immigration, anti - EU party on the far right.

Democratic Party – the current centre left governing party will be led by former Prime Minister Matteo Renzi.

What to expect:

The electoral system in Italy is notoriously complex and a coalition government is almost guaranteed.

Friday 23rd February was the last day opinion polls could be published ahead of the ballot on March 4th. Polls suggest that it will be a struggle for any of the main parties to form a government. Anti-establishment 5 Star Movement led by Luigi Di Maio is expected to be the single largest party winning, however they are not expected to gain enough to rule on their own. They have rejected the notion of striking a deal with other mainstream parties.

Polls suggest that the centre-right coalition, led by the returning Silvio Berlusconi has a better chance of securing a working majority. The group comprised of Forza Italia, the Northern League and the right-wing Brothers of Italy, could gain enough between them for a thin majority.

Meanwhile the ruling centre left Democratic Party is seen in the polls as falling marginally behind 5 Star Movement. However, the DP has the advantage of having previous coalition partners to work with, in a centre left alliance.

It is worth keeping in mind that the poll results are shaky at best. There is a huge percentage still undecided and the Italians are renowned for being a fairly fickle bunch so far as their voting preferences are concerned. If when they go to vote, the Italian economy has been performing well (as it has), they are much more likely to discard their political preference and stick with those that are delivering the current economic recovery.

The market leading up to the election:

Bond markets tend to be more sensitive to political risk. Heading towards the elections market participants appear to be very relaxed as evidenced by the fact that Italian 10-year bond yields have barely flinched since the beginning of the year. The 10-year bond yield is trading steady at 2%, down from 2.5% last March. The Italian benchmark bond is yielding 128 basis points above the German bund, showing the risk premium has narrowed considerably since April last year when it hit a peak of 213 basis points.

Whilst European stock markets have lost ground since the beginning of the year, this hasn’t been the case for the Italian FTSE MIB. Italian shares have been in demand as bargain hunters pick up the cheap banking stocks as positive economic data boosts confidence.

Market participants seem relaxed about the entire affair, because they don’t see any realistic probability of an outright majority being handed to any anti-establishment or an anti-EU candidate.

Italy has long been a politically unstable, so further instability is not necessarily a problem at all. In fact, a steady and stable political environment in a county which has had 60 leaders since World War 2 would be unusual. The key risk is whether Italy’s membership to the Eurozone could come under threat. Seeing as Italy withdrawing from the euro does not seem to be on the cards, there is a certain level of complacency going into these elections.

However, just because the markets are relaxed now, does not mean that volatility will not pick up as we head towards the event.

Markets to watch:

Whilst keeping an eye on Italian treasury yields, the euro will also be another key market to look at. Given 5 Star’s refusal to work in coalition, in the unlikely event that they win a majority, the impact on the euro is likely to be negative. Whilst the 5 Star Movement is less openly Eurosceptic than it was, distrust over their intentions will weigh on sentiment for the common currency.

Another victory for the Democratic Party (DP) would provide more continuity on the Italian political scene. This would make the markets less nervous. Given the improving performance of the Italian economy, a DP win would be the most market friendly outcome. We would expect to see the euro and the Italian FTSE MIB rally under these circumstances.

Berlusconi’s Forza Italia coalition could be a negative for the euro. Let’s not forget the Italian bond crisis of 2011, when the yield spiked to 9%. Furthermore, the anti-EU tone to the Northern League in this coalition could negatively impact sentiment for the euro.

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