Italy will go to the polls on 4th March for a vote that's crucial not just for the country but for the European Union as a whole.
Berlusconi and Renzi in the headlines
The headlines have been dominated so far by the political return of four-time Prime Minister Silvio Berlusconi, convicted of tax fraud as recently as 2013, the potential for the Eurosceptic Five Star Movement to break through as a genuine political force and the push of the Democratic Party’s Mateo Renzi to re-seize power.
The country’s electoral system is notoriously complex, a party requires a majority of 316 seats in parliament to form a government, and many observers are expecting a coalition government as the most likely outcome. And it may be that while a great deal of focus has been given to the touchy, and often divisive, subject of immigration in the run up to the election, many voters are more concerned about economic prospects.
Italy is Europe’s third-largest economy, as well as a founding member of the EU and while its economic performance has improved markedly recently, with 14 continuous quarters of economic growth, the country has still not fully recovered from the financial crisis of 2008. The economy is still 6% smaller than it was at the start of 2008 and the country is still battling historically high national debt, two factors which could influence where voters decide to cast their ballots.
Polls point to Luigi Di Maio’s Five Star Movement as likely to take a large share of the vote which should worry the EU. Still, it’s worth noting that Five Star in January backed away from a long-held threat to ditch the euro. “It is no longer the right moment to leave the euro” said Di Maio. Furthermore, the probable centre-right coalition of Forza Italia, Lega Nord, BI and others has consistently secured between 35%- 40% of the vote, according to separate pollsters, compared to 5-Star which peaked in January at 30.4%. The usual European-election cautions apply. The first far-right Bundestag and Austrian Parliament MPs for several decades show that outright election success by market-friendly politicians is not a foregone conclusion.
Risk and the euro
Nevertheless, it is likely that the market will follow the same playbook seen in last year’s French and German elections in terms of its attitude to risk. Trading looks set to remain mostly relaxed, but will become a little more volatile nearer the event. It’s worth noting that the euro has not given back much of its ascent to new three year highs in recent weeks. At the same, short-term euro option trades covering the election date have reacted more to wider market news than to election prospects. Demand for such trades is lower now than during the recent stock market turmoil.
Risk and government bonds
Similarly, it is Greek bond yield spreads, rather than Italy’s that have recently led modest widening of the spread between southern European bond yields and those of Europe’s benchmark, German 10-year bunds. Such widening is a classic sign that investors are edging away from risk. Such small moves of late appear to hang more on reckoning over how ECB tightening may impact weaker single-currency economies than on the outcome in Italy alone.
Risk and stock markets
In the event of an outcome that surprises the stock market, we anticipate that any significant upsurge in volatility would largely be contained within Italian shares. That’s not to say the wider market would ignore such an occurrence. Sizeable falls by Italian banks will echo in the sector around Europe, dragging down Germany’s DAX, as well as closer peers of Italy’s FTSE MIB index. Chiefly these are France’s CAC 40, Spain’s IBEX-35 and Portugal’s PSI-20. We would not expect any such gyrations to last. Nor would we anticipate sustained fallout. A win for the centre-right coalition would likely be met with a similarly measured relief reaction.