Political uncertainty in Italy remains high. The probability of a Government formed between the 5Star Movement (M5S) and the League (the most voted party in the centre right coalition) has increased in recent days, but the process of government formation is not straightforward. We believe there is a 50% probability to reach an agreement. If not, the next step can be a “neutral” government appointed by the Italian President and, eventually, should this option also fail, a snap election.
In case of a preliminary agreement between M5S and the League, it is worth noting that despite their electoral rhetoric, the Italian institutional and constitutional framework imposes on any new government to respect three pillars: the Euro, the Eurozone and Nato. Any explicit deviation from these international agreements would likely prompt the President of the Republic to alt any further step of government formation and would push for a “neutral” government or, if not voted in Parliament, for a snap election.
On the economic front, like for the Eurozone, we expect the Italian growth to have peaked and moderate its pace into this year and the next, albeit remaining above potential. The sentiment deterioration and the moderation of growth so far are still in line with our outlook and not too concerning, but a protracted political uncertainty could weigh on domestic drivers.
On Italian equities, main market drivers will be the recovery of financial and energy sector. We prefer the small and mid-cap segments, with idiosyncratic stories less exposed to political risk.
On Euro fixed income, at the current level of spreads and allowing for some short-term volatility, we think most of the political risk related to a populist government is priced in. However, because of this event, the higher risk premium will likely remain. We reiterate that high flexibility applied to portfolio management is necessary in order to benefit from the expected volatility that will undoubtedly arise as the ECB tapering phase approaches.
On May 7th, after a deadlock of more than 60 days, the Italian President Sergio Mattarella confirmed that political parties were not able to overcome their crossed-vetoes and sticking points. He announced his decision to appoint a “neutral” government until December 2018 at the latest and with specific tasks (including the approval of the 2019 budget law and legislating in such a way as to deactivate an automatic rise in the VAT which would kick in in January 2019). Were this government unable to find parliamentary support, President Mattarella would dissolve the Chambers and call for a snap election. But both the Five Star Movement (M5S) and the League leaders (the former is the most popular party, the latter is
the leading center-right coalition party) judged this proposal unacceptable and insistently called for a snap election, as soon as on 7th of July. Yet, as the hours passed, and likely parties started to realise the implications of this timing in terms of number of voters and risks of losing further support (in particular, this could be true for Forza Italia, the other center right main party), there was a sudden change of tide. Berlusconi (whom M5S said would have never governed with) decided not to participate to the government, letting the League and M5S progressing with the talks on a new government formation. M5S and the League asked for more time to fine tune their agreement.
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