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Investors braced as Italy plunges into new turmoil

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Italian politics is in turmoil once again as the ruling populist coalition between the far-right League and the Five-Star Movement teeters on the brink of collapse.

Italy’s senate is expected to set a date for a no-confidence vote in the government today.

After months of bickering between the coalition partners – the Five Star Movement and the League – the government collapse was expected but the timing has surprised many observers.

The cause of the latest conflict is a trans-Alpine high-speed rail link with France, which has already been in planning for decades.

The League, business groups and what is left of Italy’s political establishment is in favour. Five Star, which began as a green protest movement, has long campaigned against the rail link.

Last week, Five Star tried to block the project in the senate but was outvoted by League with help from the opposition.

“Tensions have been growing for months, especially after Five Star backed Ursula von der Leyen in her successful bid to become president of the European Commission,” said Johannes Müller, head of macro research, DWS.

“Both the League and Five Star may have been labelled populists by political scientists and various commentators, they have vastly different political priorities.

“Pretty much the only issue the two have consistently agreed on is their fierce opposition to the eurozone’s stability and growth pact, which they blame for preventing the sort of fiscal easing both promised their respective voters.”

Market jitters

Markets are understandably concerned. Italy’s 10-year bond yield fell has rose sharply last week fell yesterday after the country’s credit rating was left unchanged by Fitch Ratings.

“There is a fear that a League-dominated government would pursue unsustainable budget policies and take a more confrontational stance with the EU than the existing government,” said GianLuigi Mandruzzato, economist, EFG Asset Management.

“However, it is not obvious that new elections will happen soon. If they were postponed to the spring of 2020, Italian asset prices may get some temporary relief.”

It is also far from clear if and when snap elections might happen and Italian polling is been unreliable, making it uncertain whether League‘s polling strength (see chart) could actually translate into a centre-right majority.

The earliest a general election could be held would probably be in late October or early November, increasing the risks to the League of their electoral performance being completely different from recent polling and election results earlier in the year.

To complicate matters, any electoral campaign around that time play out just as the Italian government of the day is supposed to submit a new budget to the European Union. If it does not, Italy might be forced to raise VAT.

Risks to investors

In the short term, most investors probably wish that snap elections can be avoided but they should be careful in what they wish for, warns Müller.

“One thing that has become increasingly clear: being highly critical of austerity and trying to resist ‘reform suggestions’ from Brussels may be Italian government policy for the foreseeable future, no matter which of the major groups is in power,” he said.

At the same time, the rest of the European landscape is already changing, with the electoral victory of Spain’s socialists and the looming departure of chancellor Angela Merkel in Germany.

All this might well influence the composition of the new European Commission and could lead to more “flexible interpretations” of the EU deficit criteria concerning highly indebted countries such as Italy, Müller added

Moreover, having supported Von der Leyen’s bid to become president of the European Commission, a left-wing populist government in Rome might even find powerful allies not just in Madrid, Athens and Paris, but even in Brussels.

“When it comes to European sovereign bonds, markets have lately been firmly following the script of the Eurozone turning Japanese, in the sense of interest rates remaining low as far as the eye can see,” Müller said.

“Inflation risks have largely been priced out, not just for the immediate future but we believe for decades to come.

“Shifts in monetary policy on both sides of the Atlantic could well see the trend towards ever lower yields and ever more expensive bonds to continue for quite a bit longer.

“But when it comes to the eurozone, it will certainly seem to us that history and the continent’s changing political economy suggest an obvious alternative to Europe turning Japanese.

“A risk worth keeping in mind is that in the medium to longer-term, it could instead turn a little more like Italy was before the creation of the common currency two decades ago. That mean looser fiscal policies, and, eventually, higher inflation rates than many market participants have gotten used to.”

 

 

 

 

 

 

 

David Robinson

David Robinson is the editor of Expert Investor. He has 18 years’ experience as a business journalist and editor. In the past he has written for the Guardian newspaper and The Telegraph, and worked as...

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