Games of thrones
Italy’s upcoming election on 4 March 2018 could create some volatility. This election will be a battle fought between three main groups:
1. The centre-right: A coalition of parties led by former Prime Minister Silvio Berlusconi.
2. The centre-left: Anchored by Democratic Party (Partito Democratico or PD) which is led by Matteo Renzi.
3. Anti-establishment movement: Five Star Movement (Movimento 5 Stelle or M5S) led by Luigi di Maio.
With electoral changes, translating vote shares into parliamentary seats is not going to be straightforward and could potentially introduce more uncertainty (See Box item below for more details of Italian elections).
Recent polls indicate that the centre-right coalition is leading with 35%. The Five Star movement is polling at around 28% - the strongest showing for a single party – but is still far from forming its own majority. The centre-left coalition is polling at around 22%.
Italy Election Polls
Polls can have a wide margin of error, but without better estimations for reference, we think the current dynamics suggest the following possible scenarios:
1. Hung parliament in which no coalition has majority.
2. The centre-right coalition wins majority.
3. The Five Star leads a coalition government.
Italy’s current government is a centre-left coalition led by Prime Minister Paolo Gentiloni of the Democratic party (PD). Based on the polls, the status quo might not be tenable due to the poor showing of the centre-left coalition.
For the market, the least preferred outcome would be a coalition government led by the Five Star Movement, given past anti-Europe comments by its leaders. Nevertheless the euro-skepticism of the Five Star Movement has since moderated. Leaving the euro-area is no longer mentioned as its key agenda point.
Based on current polls, the Five Star Movement win is the least likely scenario. It would require a big upset, and a change in Five Star’s stance to gain common ground necessary to form a coalition government.
The more plausible outcome is either a hung parliament – in which no coalition has a majority - or a centre-right led coalition. Although these outcomes might be seen as more market-friendly, none of the three scenarios is likely to bring about significant economic reforms. Reduced policy effectiveness has been a common theme associated with fragmented governments.
lmost all scenarios could bring about a period of uncertainty and policy inactivity; in some cases this can be drawn out.
Solid economic backdrop mitigates election risks
The good news is that the Italian economy is on a solid footing and recovering strongly.
Italy’s growth has been positive since 2014 and has notably accelerated in recent times. That is why Italy’s current PMI is at its highest level seen in recent history.
Italy's economy in good shape
The sturdier growth trajectory, combined with a consistent budget surplus, should allow Italy to manage its debt problems and stabilise its debt-to -GDP ratio. The European Central Bank’s still dovish interest rate policy is also supportive.
The Italian banking system is getting better. The high levels of non-performing loans (NPLs) were a problem especially last year. However, the government has dealt with it most notably with the recapitalisation of Banca Monte Paschi di Siena. Italian banks in general have also been raising capital and disposing of NPLs. As a result, NPL formation is slowing down.
Italy's non-perfoming loans net of provision
Therefore, the strong economic backdrop should mitigate the risks stemming from the 4 March election.
Investment strategy - stay overweight Europe
Furthermore, the extreme scenario surrounding the upcoming Italian election – exiting the Eurozone or the possibility of a referendum – is unlikely.
All things considered, while the 4 March Italian election could create some uncertainty, it would neither spell disaster for Italy’s economy nor pose an existential threat to the Eurozone.
It is also our assessment that the Italian election will only have a limited impact on global markets. Hence, we make no changes to our overweight position for European equities.
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