- The strong performance of populist parties in Italy is balanced against Germany forming a new government. We see scope for pressure on Italian and peripheral eurozone bonds.
- A government involving populist parties might take a confrontational stance against the EU and loosen fiscal policy. We see an increased probability of another election this year.
- At the EU summit this month, the UK will likely seek agreement on a transition deal that avoids a cliff-edge Brexit in March 2019.
Results of the Italian election point to a hung parliament, with no party or coalition winning enough votes to form a government. The strong showing of populist parties complicates the Italian political outlook but is balanced against a new government forming in Germany.
The right-wing, euroskeptic Northern League (Lega Nord) party, led by Matteo Salvini, is emerging stronger than Silvio Berlusconi’s center-right Forward Italy (Forza Italia) party within the center-right coalition, which also includes the far-right Brothers of Italy (Fratelli d’Italia) party. The independent and also euroskeptic Five Star Movement (Movimento 5 Stelle or M5S) led by Luigi di Maio has beaten poll forecasts and won a greater share of the vote than expected – not enough to form a government, but enough to make it a linchpin in any potential government. Matteo Renzi’s center-left Democratic Party (Partito Democratico) appears to have fared the worst.
We believe it unlikely that Five Star will partner with the Northern League to form a government. The Northern League’s ambition is to lead the center-right coalition rather than be a junior partner in an unstable alliance with Five Star. At some point, an increasingly mainstream Five Star and the Democratic Party may warm up to each other.
We see scope for pressure on Italian and peripheral eurozone government bonds but don’t see this as a sustained negative for the euro or regional equities. A new Italian parliament needs to be convened by March 23, yet negotiations are likely to drag on beyond then. Political noise is poised to remain high until a sustainable coalition emerges.
At the same time, a healthier Italian economy looks likely to cushion some of the short-term hit. The Bank of Italy’s real GDP growth estimate of 1.5% in Italy looks realistic for 2018-2019, though ongoing political uncertainty may be a drag. We consider that the debt-to-GDP ratio should start falling from this year.1 Italy’s banking sector appears to have turned the corner and is making progress in dealing with the large non-performing loans on its books.