As if Europe hasn’t got enough on its plate — war in the east, rampant inflation and an energy crisis are all currently highly deleterious and interlinked.
Now this weekend looms a general election in Italy, where according to forecasts the poll may deliver a far-right coalition led by Giorgia Meloni of the Brothers of Italy, a party with fascist roots, populist fiscal policy and a deep euro-skepticism.
So, what does a putative Meloni government mean for markets, within Italy and beyond? Here are some things to consider.
Watch the spread. The yield spread between benchmark Italian 10-year government debt (BTPs) TMBMKIT-10Y, 4.202% and their German equivalents TMBMKDE-10Y, 1.980% is the most closely followed gauge of how investors view the Mediterranean country’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’s — 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 230 basis points, suggests the market is relatively sanguine for now about a Meloni-led administration, betting that its desire to provide inflation-busting subsidies to households and business will be constrained by its desire to tap assistance from the European Union and the bloc’s central bank.
Paolo Pizzoli, senior economist for Italy and Greece at ING, says that should the expected new government deliver few wholesale changes to the 2023 budget then 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 grouping may encourage it to risk breaching its 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 rates strategists.
Geopolitical tensions and the euro. Meloni has stated that she will not only stick to former prime minister Mario Draghi’s fiscal policies but also 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, have long been admirers of Russia’s Vladimir Putin and question whether sanctions against Moscow that are seen impacting Italians’ living standards 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.”
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 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, -0.82% is down about 20% for 2022, only slightly underperforming the Stoxx 600’s SXXP, -1.49% 18% drop. The FTSE Italia All-Share Banks sector IT8300, +0.54% is down 19% for the year but analysts say a wider Bund/BTP spread would make life more difficult for financials.
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 five years ago, it means the sector is highly exposed to the bonds falling in value and eroding their capital reserves.