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Does the political turmoil in Italy have wider ramifications?

25 May 2018

The Italian election in March was closely watched by European investors, given concerns about the growing popularity of the far-right League and the anti-establishment Five Star Movement. The latter won 32% of the vote and the former 18%, with incumbent Prime Minister Matteo Renzi's centre-left Democratic Party only managing 23%. Importantly, within the centre-right coalition, the more populist League surpassed Berlusconi's 'Forza Italia' party for the first time. This outcome left no party with an outright majority, and the chances of a coalition government seemed slim given the significant differences in policy stance between the three.

Following a period of limited progress and expectations of another election later in 2018, a seemingly improbable coalition between the two populist parties, Five-Star and League, has emerged. The two groups have agreed on a 'government contract' (including the key policies they want to address) and have appointed a political newcomer, Giuseppe Conte, to be Prime Minister. While consented to by both Five-Star and League, it should be noted that he is closer to the former and his appointment represents a 'de-facto' victory for the anti-establishment Five-Star Movement.

While the two groups insist in defining Conte as Prime Minister of a "political government", many are worried that the newly elected Prime Minister will merely be an 'executor' of populists' wishes, not different from prior 'technical' Prime Ministers. Among other controversial aspects, allegations that he lied on his prior academic experiences have emerged. This demonstrates the difficulties that there will be in getting anything through this coalition.

President of the Republic, Sergio Mattarella, has now granted Conte a mandate to form a government, which entitles him to nominate ministers in the coming days. Stated policies of the parties include a 'citizen's income' to those in low-paid work or searching for a job, significant cuts in corporation and income tax and a reversal of prior pension system reforms. If these all materialise, there is potential for a surge in the budget deficit and debt, as well as further strain on the largely loss-making banking system. What would be more concerning is any sanction from the EU for breaking budget rules, which could embolden the new coalition on direct collision course with the union.

Since the French election in 2017, investors have appeared willing to discount political risk in the region, sensing that the populist wave had no real ambition to break up Europe. However, the immediate market impact signals this sentiment has shifted. The yield on Italian sovereign debt has shot up and the spread over German bunds reached 190bps, a level not seen in a year. Reaction has not been limited to Italy, with Euro breakup risks now being factored into market pricing. Banking debt and peripheral stock markets have been the most affected. Whilst the Italian FTSE MIB (Milano Indice di Borsa) Index has fallen 6% in the past month, it remains in positive territory for the year.

Clearly, the situation is still evolving and until key ministers have been elected, such as the finance minister, a true picture of future policy is difficult to forecast. Investors will be aware that polls in Italy show a high degree of EU scepticism so the propensity for the situation to escalate will continue to weigh on markets. It is worth mentioning that incredibly, this is the 66th government in Italy since the end of World War II and with such a divide on numerous fronts, we feel that it is unlikely that this one will last over the longer term.

 

 

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LGT Vestra LLP is authorised and regulated by the Financial Conduct Authority (FCA).

This communication is provided for information purposes only. The information presented herein provides a general update on market conditions and is not intended and should not be construed as an offer, invitation, solicitation or recommendation to buy or sell any specific investment or participate in any investment (or other) strategy. The subject of the communication is not a regulated investment. Past performance is not an indication of future performance and the value of investments and the income derived from them may fluctuate and you may not receive back the amount you originally invest. Although this document has been prepared on the basis of information we believe to be reliable, LGT Vestra LLP gives no representation or warranty in relation to the accuracy or completeness of the information presented herein. The information presented herein does not provide sufficient information on which to make an informed investment decision. No liability is accepted whatsoever by LGT Vestra LLP, employees and associated companies for any direct or consequential loss arising from this document.

LGT Vestra LLP is authorised and regulated by the Financial Conduct Authority (FCA).

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