Business World

Monday 21 January 2019

Markets and eurozone on alert amid fears of shock result in Italian election

There is speculation that Italian Prime Minister Matteo Renzi’s ruling Democratic Party (PD), which is trailing in the polls may seek to form a coalition with Silvio Berlusconi’s Forza Italia. Photo: Getty Images
There is speculation that Italian Prime Minister Matteo Renzi’s ruling Democratic Party (PD), which is trailing in the polls may seek to form a coalition with Silvio Berlusconi’s Forza Italia. Photo: Getty Images

Zak Kacem

Today the Italian electorate heads to the polls for the first time since a new electoral law came into place. Despite much less hype than the Brexit vote or the French presidential election, a great deal hangs in the balance - for Italy and the eurozone - on the outcome of the vote.

As the EU's third-largest economy, Italy has a high public debt and was very much at the centre of the sovereign debt crisis that hit Europe in 2011. Between 2009 and 2013 the Italian economy shrank by over 5pc and a substantial dose of austerity was administered by a technocratic government that ran the country for 18 months after Prime Minister Berlusconi's forced resignation in late 2011.

This, in turn, gave rise to anti-austerity and euro-scepticism in Italy, which remains of concern to investors and the wider eurozone. EU officials have recently become vocal on this: the president of the EU commission, Jean-Claude Juncker, said Europe should be prepared for "the worst scenario" and warned of a "strong reaction" on financial markets.

Additionally, some high-profile investors, such as Bridgewater's Ray Dalio, have been shorting Italian and European stocks over recent months as they believe that rising populism - of the sort espoused by the Italian Five Star Movement [M5S] - remains a tangible macro and political risk for Europe.

Whereas recent economic news from Italy and the broader eurozone may stymie the march of anti-establishment parties, that is far from certain, as surprise votes in favour of Brexit and Trump will attest. An unexpected outcome in today's vote would unsettle international markets and have far-reaching and unintended consequences.

The main contenders

Since 2009, the Italian anti-establishment group M5S, has developed a fairly antagonistic stance toward the EU, the single currency, austerity, and high finance. This approach underpinned the movement's popularity winning 25pc of parliament seats in the 2013 election. Since then M5S was instrumental in former Prime Minister Renzi failing to secure proposed reforms in the 2016 referendum.

Formed in 2009 by comedian Beppe Grillo, M5S markets itself as a non-political party, refusing any traditional labelling. It is currently leading opinion polls at 28pc and is set to be the biggest individual party.

The name, '5-Star', refers to its stance on five flagship issues; publicly-owned water, sustainable transport, sustainable development, right to internet access and environmentalism. Now led by Luigi Di Maio, the growing popularity of this group may still come up short to form a single party government.

The centre-left coalition, led by Matteo Renzi's ruling Democratic Party (PD), is only third in polls with circa 23pc support. However many speculate that Berlusconi's Forza Italia might seek to form a grand coalition government with the PD.

The centre-right coalition is currently comprised of Forza Italia, and two far right parties: Lega & Brothers of Italy (FdI). It is a rather mixed bag as Forza Italia is a moderate (socially conservative, economically liberal) party, while Lega and Brothers of Italy are far right Euro-sceptics. That is not all; Lega has a regionalist-federalist philosophy while FdI is rather nationalist in its policies.

Another hung parliament?

New electoral laws, which were voted in last year, make it almost impossible for any single party to win the necessary majority to form a government. Many have argued this law was intended to complicate matters for the M5S, which despite sitting comfortably ahead in polls, is unlikely to achieve an overall majority. This is further complicated as M5S consistently rules out an alliance with more 'traditional' parties, an approach that would see it come up short against the centre-right coalition.

Ideologically, M5S claim to be neither a left-wing nor a right-wing group. However, upon reading their manifesto one will find a very leftist slant with slogans such as: less banks, more real economy.

Fiscal Expansion

From an economic perspective, most of the parties (although not so much the ruling PD) have included in their manifestos a number of generous promises that implies expansionary fiscal policies not consistent with the country's high public debt level. A more extreme expansionary stance, by a Euro-sceptic led government, could undermine recent economic growth in Italy and create instability for the single currency and the wider EU.

That has to loom large on minds of the electorate. Despite the substantial dose of austerity that was administered in recessionary times, are the voting public willing to put current growth on the line in favour of an anti-establishment?

Cautious Markets

Markets are taking nothing for granted. Since February 7, the Italian FTSE MIB stock index has started to lag the broader Stoxx Europe index and the yield spread between Italian and German 10-year bonds - a measure of perceived risk on Italian sovereign debt - has also started to rise.

Notwithstanding this concern, the considered view is that contenders are softening their rhetoric and no one party is likely to govern alone.

The most likely outcome therefore is a 'non-political' or grand coalition government whose more radical policies would likely be sufficiently diluted to ease any substantive threat to Italy's recent growth story... but remember Brexit and Trump.

Warning: Past performance is not a reliable guide to future performance. The value of investments may go down as well as up.


Zak Kacem is a portfolio manager in Davy Private Clients. Views expressed in this article reflect the personal views of the author and not necessarily those of Davy. Davy Private Clients is a division of J&E Davy. J&E Davy, trading as Davy, is regulated by the Central Bank of Ireland.

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