Summary
While hopes are rising of a resolution to the political upheaval in Italy, investors will be focused on the country’s weaker economic outlook.
Italy’s economy has been doing better, but confidence could be threatened by rising yields and uncertainty, despite some proposed fiscal stimulus and lower taxes.
Despite market fears, there appears to be little appetite among Italians to leave the euro, as differences centre on the constraints of EU budget levels.
We don’t foresee any major response from the ECB to Italy’s troubles; market pressures should help direct a sensible set of domestic policies.
We remain neutral to cautious on Italian assets for now, as we face a summer of uncertainty.
The political upheaval in Italy has raised a number of fears, not least that Europe’s fourth-largest economy may want to withdraw from the European Union, if not subvert the euro with a parallel currency too. We view both events as unlikely, but the mere prospect of them occurring – amid continuing political uncertainty – caused cascading market reactions: yields on Italian debt soared as prices plummeted; a selloff in Italian equity markets spilled over to the US; and the euro fell to its lowest level against the US dollar this year. At the climax of the recent crisis, markets were pricing in a high probability of default on Italian debt, with no possibility of outright monetary transactions (OMT) by the ECB. The subsequent re-steepening of the yield curve is a welcome sign of normalisation.
Two possibilities: elections in September or a new political government
The political environment in Italy is fast-changing. Since parliamentary elections in March, which resulted in a hung parliament with no party or coalition winning a majority of seats, Italy hasn’t had a government. On May 27, President Sergio Mattarella rejected the nomination of an economics minister whom he considered anti-EU and anti-euro. This triggered the latest surge of market volatility globally and raised the spectre of his impeachment.
From our perspective, Italy’s political situation boils down to two possibilities – both of which are likely to create a degree of certainty that may buoy financial markets in the short term:
- The first is the formation of a caretaker government, led by interim Prime Minister Carlo Cottarelli, followed by a new round of elections that would effectively be a referendum on Italy’s role in the EU. We believe that September is a more likely date for these elections.
- The second possible scenario is the formation of a new political…
