Growing concern before the election in Italy

Italy goes to the polling booths on 4 March to elect a new parliament. The left-wing populist Five Star Movement (M5S) can, as recent surveys suggest, expect to bag close to 28% of the votes and would thus emerge the largest party. Partido Democratico (PD) places second in the surveys at about 24%; however, its approval ratings have recently dropped. A right-wing alliance of Forza Italia, Lega Nord and Brothers of Italy would, so the pundits believe, place well ahead of all others, claiming about 35% of the vote in total. With this year’s election, the main uncertainty is gauging what impact the new election laws including the first-past-the-post component will have. Since the surveys primarily focus on the relative portion of the votes each party will win, they offer only a limited indication of the overall distribution of seats in the new parliament.

None of the parties or alliances can expect to land an absolute majority of the seats. M5S may emerge the largest party but it has thus far excluded a coalition with other parties. The most probable option will presumably be that the right-wing alliance and the PD enter talks to form a coalition. At present, the parties are all busy outdoing each other with calls for lower taxes and / or higher government spending. Given a sovereign debt ratio of about 132%, the second highest in the EMU, there is the threat of the country’s ability to shoulder its debts (above all in a future economic downturn) deteriorating further. Should talks come to nothing, then there would be new elections within 70 days of the new parliament being dissolved.

In early December, markets have started pricing the election risk into Italian government bonds. In the ten-year maturity segment, risk premium spreads have since increased appreciably. Nervousness among investors may persist until the vote has been cast. The greatest worry in the market: that the Euro-sceptics at the M5S perform well in the elections and despite having hitherto refused to collaborate with other parties then become part of a government after all. Should a form of collaboration – be it a coalition or a minority government – emerge after the ballot between the right-wing alliance and the PD, the markets will probably be relieved. Things would be different if the M5S looked like becoming part of the government. At least in the short term, risk premiums would then increase significantly. Moreover, the rest of the government bond segment would probably be affected, with capital flowing from the periphery in the direction of the core EMU member states.

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