As if Europe hasn’t got enough on its plate — war in the East, rampant inflation and an energy crisis — now Sunday’s general elections in Italy is poised to deliver a far-right coalition led by Giorgia Meloni, whose Brothers of Italy party has fascist roots, a populist fiscal policy and deep Euro-skepticism.
So what would a Meloni government mean for markets, both within Italy and beyond? Here are some things to consider.
Watch the spread. The yield spread between the benchmark Italian 10-year government bond (BTP Italia) TMBMKIT-10Y, 4.353% and the German equivalent (Bund) TMBMKDE-10Y, 2.024% is the most closely followed gauge of how investors view Italy’s prospects.
Generally, the greater the angst about Rome’s fiscal position — it has a debt-to-GDP ratio of about 150%, double that of Berlin — the greater the yield differential, as investors demand more income for taking on the perceived risk of holding Italian paper.
The good news is that the spread, currently around 220 basis points, suggests that for now, the market is relatively sanguine about a Meloni-led administration, betting that its desire to provide inflation-busting subsidies to households and businesses will be constrained by its need to tap assistance from the European Union and the bloc’s central bank.
Paolo Pizzoli, senior economist for Italy and Greece at ING ING, -5.89%, says that if the expected new government delivers few wholesale changes to the 2023 budget, markets would consider that a welcome sign of budgetary restraint.
Source: FactSet
“Much is riding on this. Besides the credibility of the new government on fiscal matters, any clear departure from the EU’s guidelines would raise fears that Italy could lose out on €69 billion in grants and €123 billion in loans from the NextGeneration EU recovery package, and may also no longer be eligible for European Central Bank support,” Pizzoli says.
However, some analysts are wary that a landslide victory for the far-right coalition could encourage it to risk breaching EU agreements on spending and structural reforms.
“A negative scenario of a 2/3 majority of seats for the right could still spook markets, with the BTP-Bund spread likely widening towards the 275bp area,” according to Citi C, -2.90% rates strategists.
Geopolitical tensions and the euro. Meloni has stated that she will stick not only to former prime minister Mario Draghi’s fiscal policies but also to his foreign policy stance, particularly with regard to the West’s support for Ukraine against Russia.
However, other senior members of the coalition, notably Matteo Salvini, leader of the League party, have long been admirers of Russia’s Vladimir Putin and question whether sanctions against Moscow that are seen as affecting Italians’ standard of living are a price worth paying.
A split with fellow EU members on this issue would likely further damage the single currency, says Piero Cingari at Capital.com.
“So far this year, the performance of the euro has been totally dominated by more pressing factors than the Italian elections, such as the monetary policy and the energy crisis in Europe, which have pushed the single currency below the parity levels against the dollar,” Cingari writes.
“However, it cannot be ruled out that a deterioration in relations between the Italian government and Europe would have an impact on the single currency at a later stage,” he writes.
ING’s Pizzoli is more sanguine: “When Italian politics start to appear on the market’s radar, downside risks to the euro often start to emerge … [but] markets may welcome a result that yields a stable majority, and barring some unwelcome surprises … Italian political risk might have a rather muted impact on the euro into the new year.”
Italian banks. The economic background is not great for domestically focused Italian companies, particularly in the financial sector.
A recent survey of economists conducted by Bloomberg sees the Italian economy growing only 0.4% next year, down from 3.3% in 2022, as surging energy prices and rising interest rates take their toll.
The FTSE MIB index I945, -3.36% is down about 23% for 2022, only slightly underperforming the Stoxx 600’s SXXP, -2.34% 20% drop. The FTSE Italia All-Share Banks sector IT8300, -4.18% is only down 17% for the year, but analysts say a wider Bund-BTP spread would make life more difficult for financial firms.
JPMorgan analysts calculate that holdings of BTPs at Italy’s top five banks amounted to 1.5 times their core capital. Though this was down from 2.6 times core capital five years ago, the sector remains highly exposed to the bonds falling in value and eroding the banks’ capital reserves.