Italian Elections head for a hung Parliament

Andamento del mercato - 28/02/2018

Investors are still confident ahead of Italy’s March 4 election. In general, the economy of the Eurozone is strengthening and euro skeptics are losing strength in the single-currency bloc.

But March 4th has the potential to be the inflection point.

Italian elections will be the same day as Germany finds out the results of a Social Democrat party members vote regarding the coalition deal with Chancellor Angela Merkel’s conservatives. The outcome is crucial as it can seal or end Merkel’s hopes for a fourth term in office. The German result is also important for southern European countries including Italy since a new coalition is expected to take a more pro-European approach to fiscal policies in the bloc.

According to the latest polls a hung parliament gathers a higher percentage, where no one party or coalition has a majority to form a government.

If this happens, Italian President Sergio Mattarella, will call on parties to form a broader coalition. According to analysts, in the case of a hung parliament, the most positive outcome for the markets would be a coalition that includes mainstream parties since it could result in political stability and policy continuity on Europe.

Even in this situation, any uncertainty over the government’s make-up could possibly lead to short-term volatility. Political uncertainty, as experienced during the French and German elections, has become a key force for major currency markets over last year and serious attention needs to be paid to Italy’s election.

A coalition of center-right parties is leading in the polls and it could win a majority of its own.

The biggest surprise would be the victory of the anti-euro Northern League center-right party, which calls the euro a “failed currency.” Uncertainty could spread fear over the Euro and widen the gap between Italian and German bond yields.

An election outcome that allows another anti-euro party, the 5-Star Movement, to have a major role in government may have the same effect. The 5-star lead by Luigi Di Maio is even calling for a referendum on the euro membership and raise the budget deficit above 3% of GDP and cut taxes.

In the case a government is not formed, fresh elections will have to be made.

Finally, the election will use for the first time a new voting system introduced last year, which makes the outcome particularly uncertain.

Whatever the outcome might be there are very few chances that the next government will push through structural reforms to improve Italy’s economic performance or to tackle the country’s debt pile. Italy has the European Union’s worst debt ratio after Greece at 132% of GDP.

In the case Italy’s election passes without major issues, it will remove a layer of political risk from the calendar and reinforce the case for unwinding ECB stimulus.

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