27th February 2013
Fund managers are warning that the Italian election result could open up a new chapter in the eurozone crisis as the overwhelming majority vote against austerity. Experts are even warning there is a chance of an Italian referendum on EU membership.
Political uncertainty until mid March
Jack Kelly, Standard Life’s investment director for global government bonds says that uncertainly will continue until at least mid March and that we may see another uneasy compromise between the left and right political groups with Bepe Grillo’s 5 Star movement standing apart.
Kelly adds: “The Italian elections have prompted a fresh bout of uncertainty in European bond markets with peripheral spreads widening sharply on the inconclusive result. The most likely development from here will be an uneasy compromise between Pier Luigi Bersani’s centre-left and the centre right to agree to a loose grand coalition in order to avoid another election and stall the momentum gained by Beppe Grillo’s Five Star movement. This will be a fraught process and we are unlikely to get clarity until at least March 15th when the Houses are scheduled to meet.”
Derry Pickford, macro analyst at fund managers Ashburton says it means the overwhelming majority of Italians voted against austerity. He gives a detailed assessment of the electoral arithmetic below.
“In the vote for the lower house, Comedian Beppe Grillo’s Five Star Movement (5SM) got the biggest share of any single party at nearly 25.6 per cent of the vote. However, 5SM was behind Bersani’s “Common Good” coalition of social democratic socialist and green parties, which totalled 29.6 per cent, and Berlusconi’s coalition of conservative nationalist and regional parties at 29.2 per cent. This meant that the majority of Italians voted against austerity. The only group advocating pure ECB orthodoxy, Monti’s centrist coalition, got 10.6 per cent of the vote. Bersani takes the lower house by virtue of leading the biggest coalition (54 per cent of seats automatically go to the largest coalition regardless of the margin of victory). Although both Bersani and Berlusconi did marginally better in the share of the Senate vote, Bersani failed to get a controlling majority either alone or with Monti’s centrists. This will make formation of a new government tricky. The best case for Bersani is that he is able to build a grand coalition; the worst is that we get yet more elections and that Berlusconi and Grillo win a majority. An alternative scenario is that Bersani may be able to tempt some members of the 5SM with promises of reforms that tackle corruption and vested interests as well as improved internet infrastructure.”
Standard Life says that while the whole approach of the European Central Bank has introduced measures to give countries time to reform that does not take into account the rise of protest and anti-establishment parties across Europe.
Kelly says: “Of course Italy is used to unstable government and the immediate downside for Italian bond spreads is capped by the potential activation of ECB support in one form or another. However, we are of the view that the Euro-zone crisis is set to continue, and that recent excessive optimism has been misplaced as the underlying causes of the crisis have not yet been properly addressed. The European financial system is still dysfunctional, with credit not flowing to intended recipients. The absence of Eurobonds still prompts uncertainty over peripheral sovereign debt.”
“What this episode does again underline is that while the ECB is trying to buy time for governments to enact reform, the environment of continued enforced austerity and low growth leads to a more fractious political scene, with the rise of protest and anti-establishment parties across Europe. We are positioned underweight in the periphery and underweight the Euro in our bond funds.”
Could there be an in-out referendum?
Standard Life Investments Head of Global Strategy Andrew Milligan says: “At the very least, a prolonged period of uncertainty faces the Italian economy, affecting investor sentiment. In coming months, fiscal slippage and obstacles to structural and labour market reforms would not at all be well received by global investors. Investors have to think about tail risks. The probability is low, but not negligible, that Italy will have a referendum on EU membership before this political crisis comes to an end.
“Only about 1 in 10 Italian voters, on a low turnout of 75%, actually supported Monti, the politician whose policies are closest to the European mainstream. Despite the political furore about the UK losing its AA status, it should be remembered that, for example, Standard & Poors rates Italy BBB+ with a negative outlook.”
Pickford adds: “Both Grillo and Berlusconi have flirted with the idea of a referendum on Italy’s membership of the Euro and this is what really scares markets. Any question about Italy’s commitment would raise “convertibility” premia. This should mean that the ECB would step in with Outright Monetary Transactions (OMT) but OMT is conditional on Italy following a path of fiscal consolidation. This could set up a dangerous game of chicken between a future Italian administration and the ECB, with Merkel on the other side. So far, European policymakers have managed to avoid disaster and we still think they will do the right thing eventually, but in the mean-time markets could have a real fright.”