Italy’s right-wing bloc wins the election: five questions to the markets
MILAN/LONDON, Sept 26 (Reuters) – Italy’s right-wing bloc is expected to have a solid majority in both houses of parliament after Sunday’s elections, potentially giving the country a rare chance for political stability after years of upheaval and fragile coalitions.
Giorgia Meloni, leader of the Nationalist Brotherhood of Italy, is set to become Italy’s first female prime minister to lead its most right-wing government since World War II.
The absence of anti-euro rhetoric observed during the 2018 election had reassured investors as the vote approached. A poor League result from Matteo Salvini, the less pro-European party, could also be a relief.
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However, Meloni and his allies face an impressive list of challenges, including soaring energy prices, war in Ukraine and a renewed slowdown in the eurozone’s third-largest economy.
As the markets watch closely, we take a look at five key questions on the radar.
1/ Is the prospect of political stability positive for the markets?
Maybe. Meloni’s comments during the election campaign that she would stick to EU fiscal rules reassured markets and a slight underperformance in Italian bonds on Monday could be as much due to global market unease as a reaction to the outcome.
At around 230 basis points, the closely watched spread between Italian and German 10-year bond yields remained relatively stable .
But pressure on bonds could increase as the focus shifts to fiscal policy in 2023. Despite Meloni’s reassuring tone, worries about a potential conflict with the European Union could grow if right-wing parties push to lower taxes and higher pension spending.
Moreover, we do not see the right winning a two-thirds majority in both houses of parliament, which would allow the constitution to be changed without a referendum, which could have caused anxiety since the constitution protects questions related to the accession of Italy to the EU.
“We don’t expect an immediate push for major fiscal easing, but we see medium-term risks that the right-wing political agenda will conflict with EU goals,” Giada said. Giani, economist at Citi.
“Meloni’s first key decision will be the appointment of the finance minister, with a pro-European and fiscally cautious figure looking like a likely choice for now,” she added.
2/ Could Italy’s European financing plan be modified?
The Brothers in Italy see the possibility of modifying Italy’s EU-backed recovery fund program to take account of the energy shock. Read more
To receive the next tranche of funds in December, Rome must meet 55 new targets, which a party official said would need to be adjusted. Brussels said only an adjustment to the agreed recovery plan was possible. Read more
The party said it would not jeopardize access to the program, but changing plans could jeopardize the funds, worth 19 billion euros ($18.3 billion) or 1% of the GDP, said Rabobank economist Maartje Wijffelaars ahead of the vote. Read more
3/ What does a new government mean for the Italian debt?
Italy is one of the most indebted states in the world, with a debt as a percentage of gross domestic product of 151%. This ratio is expected to fall this year, but could rise further if payments from EU funds are insufficient, which will hurt economic growth.
Concerns over Italian debt pushed 10-year bond yields above 4% . Moody’s and S&P lowered their outlook for Italy’s rating after Mario Draghi stepped down as prime minister in July. Read more
“We expect a rather subdued market reaction in terms of BTP credit spreads in the near term as the election outcome was broadly in line with expectations,” UniCredit strategists said, adding that short hedging was also possible.
4/ Could the European Central Bank activate its anti-fragmentation tool?
Rising borrowing costs in a heavily indebted Italy are testing the ECB’s resolve to contain tensions in the bond market.
Italy’s election had been seen as a short-term obstacle to the ECB activating its Transmission Protection Instrument (TPI) – a new tool to prevent weaker government borrowing costs to stray too far from the top-rated Germany through no fault of their own.
The ECB is unlikely to use the TPI any time soon, but its presence should help support Italian bonds. Read more
5/ What will the results mean for Italian banks?
The sector is in better shape than at the time of the 2018 elections, when populist parties’ anti-euro rhetoric rattled investors.
Italian banks have a stronger capital base and are less exposed to sovereign stress than they were ten years ago. Cheap valuations, rising rates and reassuring comments from Meloni in favor of the EU also mean Italian lenders look attractive, analysts and investors said.
But the economic outlook will eventually prevail, and with recession risks growing, betting on the banks could be risky. Italian banking stocks (.FTITLMS3010) outperformed Eurozone banks (.SX7E) early Monday.
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Reporting by Danilo Masoni, Stefano Rebaudo, Sara Rossi and Alessia Pe in Milan, Yoruk Bahceli in Amsterdam and Dhara Ranasinghe in London, Editing by Kirsten Donovan
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