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Investment Comment: Italian Election Result Highlights Eurozone Woes - Schroders
Azad Zangana
Schroders
27 February 2013
Editor’s note: There has been plenty of commentary from the wealth management sector about the impact of this week’s Italian national elections. The polls saw Mario Monti, the man at the head of the previous government, left without enough votes to secure power. The vote has already hit equity markets owing to concern that reforms will falter. Choosing from a number of items, this publication decided to share these thoughts from Azad Zangana, European economist at Schroders, the UK wealth and investment house. Following months of campaigning and deal making, the final results of the elections in Italy appear to have resulted in gridlock. Pre-election poll favourite and leader of the centre-left coalition Pier Luigi Bersani has won the race for the lower house by a wafer-thin majority, but failed to win enough votes to take the equally important upper house (senate). Bersani’s polling was not strong enough to suggest that he would be able to take the senate, but he was expected to join forces with the previous technocratic leader Mario Monti in order to secure enough votes. Unfortunately, both Monti and Bersani failed to secure enough votes for this outcome. Former prime minister Silvio Berlusconi did better than expected in the end but the surprise outperformer was former comedian Beppe Grillo, leader of the Five Star Movement party, who has built his campaign on an anti-establishment, anti-austerity message. Grillo has publicly criticised Germany in its role in influencing European policy and has in the past called for a referendum on Italy’s membership of the euro. The next stage will be determined by the President of the Republic, Giorgio Napolitano, who has three options: The first is to invite a party/coalition to attempt to form a bi-partisan government in the senate (with at least 158 seats). This is the most likely option and will probably be done through Bersani given his lower house victory. If Bersani is successful in forming a broad coalition, then it will probably focus on reforming the electoral laws and cutting the size of government - two issues that the majority of parties agree with. However, this would most probably lead to no further progress on austerity or economic structural reforms. The second option would be to install a technical government that would be in place to simply nod-through laws/legislation from the lower house. The third choice would be to call for another general election immediately. This option is risky as it prolongs political uncertainty, especially as, without reforms of the voting system, the result will probably be another stalemate. Best option Given the circumstances, the second option would be ideal, but would lack the support of the people, especially with how small Bersani’s margin of victory was. The first option of a bi-partisan coalition would mean no further progress, but equally, no reversal of Monti’s unpopular reforms which Berlusconi had been promising. Finally, a re-run election without tremendous market pressure is unlikely to change the results to a pro-reform government. The Italian parliament is due to reconvene on 15 March, which should be the start of the first round of negotiations. The market’s reaction has been understandably negative. At the time of writing, the spread between the 10-year Italian government bond yield and the German bund yield is 37 basis points higher, while the FTSE MIB equity index is down just over 4.5 per cent today . The negative performance has not been restricted to Italian markets with most European bourses down today, after falls in the US and Asia overnight. Could the European Central Bank do something to alleviate market stress? This is unlikely as its current weapon of choice - outright monetary transactions - are reserved for member states that sign up to a bail-out programme, which of course would require a government to sign off for. In addition, a qualified majority (85 per cent of votes) would be required to activate the ECB’s bond buying programme. Overall, it appears that eurozone political uncertainty is back and investors should expect higher volatility as more weight is placed on political news-flow. Italy is still in a better situation than when Mario Monti took over from Silvio Berlusconi in November 2011. Italy is close to running a surplus in its public finances, and has made some progress on structural reforms. The key for Italy will be to ensure the progress made so far is not reversed, and to manage market sentiment and expectations.