Azad Zangana, European Economist
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For professional investors and advisers only. This document is not suitable for retail clients.
Pre-election poll favourite, and leader of the centre-left coalition, Pier Luigi Bersani has won the race for the lower house by a wafer-thin majority, but failed to win enough votes to take the equally important upper house (senate). Bersani’s polling was not strong enough to suggest that he would be able to take the senate, but he was expected to join forces with the previous technocratic leader Mario Monti in order to secure enough votes. Unfortunately, both Monti and Bersani failed to secure enough votes for this outcome.
Former Prime Minister Silvio Berlusconi did better-than-expected in the end, but the surprise outperformer was former comedian Beppe Grillo, leader of the Five Star Movement party, who has built his campaign on an anti-establishment, anti-austerity message. Grillo has publically criticised Germany in its role in influencing European policy, and in the past has called for a referendum on Italy’s membership of the euro.
The next stage will be determined by the President of the Republic Giorgio Napolitano who has three options:
1. The first is to invite a party/coalition to attempt to form a bi-partisan government in the senate (with at least 158 seats). This is the most likely option and will probably be done through Bersani given his lower house victory. If Bersani is successful in forming a broad coalition, then it will probably focus on reforming the electoral laws and cutting the size of government – two issues that the majority of parties agree on. However, this would most probably lead to no further progress on austerity or economic structural reforms.
2. The second option would be to install a technical government that would be in place to simply nod through laws/legislation from the lower house.
3. The third choice would be to call for another general election immediately. This option is risky as it prolongs political uncertainty, especially as without reforms of the voting system, the result will probably be another stalemate.
Given the circumstances, the second option would be ideal, but would lack the support of the people, especially given how small Bersani’s margin of victory was. The first option of a bi-partisan coalition would mean no further progress, but equally, no reversal of Monti’s unpopular reforms, which Berlusconi had been promising. Finally, a re-run election without tremendous market pressure is unlikely to change the results to a pro-reform government. The Italian parliament is due to reconvene on the 15th of March, which should be the start of the first round of negotiations.
The market’s reaction has been understandably negative. At the time of writing, the spread between the 10-year Italian government bond yield and the German bund yield is 44 basis points higher, while the FTSE MIB equity index is down just under 4.5% today. The negative performance has not been restricted to Italian markets with most European bourses down today, after falls in the US and Asia overnight.
Could the European Central Bank (ECB) do something to alleviate market stress? This is unlikely as its current weapon of choice – outright monetary transactions – are reserved for member states that sign up to a bailout programme, which of course would require a government to sign off for. In addition, a qualified majority (85% of votes) would be required to activate the ECB’s bond-buying programme.
Overall, it appears that eurozone political uncertainty is back and investors should expect higher volatility as more weight is placed on political news flow. Italy is still in a better situation than when Mario Monti took over from Silvio Berlusconi in November 2011. Italy is close to running a surplus in its public finances, and has made some progress on structural reforms. The key for Italy will be to ensure the progress made so far is not reversed, and to manage market sentiment and expectations.
Important Information:
For professional investors and advisers only. This document is not suitable for retail clients.
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Source: ETFWorld – Schroders
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