Italy Election Results: Focus on the Fundamentals
While the strong showing of the anti-establishment Five Star Movement was the story of the night, the initial results of Italy’s election indicate a hung parliament. The question for investors is whether the political uncertainty will overshadow the country’s improving economic fundamentals.
Early results from Italy’s Parliamentary elections suggest a hung parliament with no party or coalition winning a majority of seats.
The three largest blocs – the centre-right coalition, the centre left coalition and Five Star Movement (M5S) – secured around 37%, 24% and 31% of the votes respectively.
Two results stand out: the strong showing of the anti-establishment M5S and League parties and, conversely, the poor performance of the more moderate Democratic Party (PD) and Forza Italia (FI). M5S will be the largest party in parliament, while the League will hold the leadership in the centre-right coalition.
The new parliament will convene on 23 March to elect the speakers of the Senate and the Chamber of Deputies. This represents the first opportunity for alliances to be made and there may be hints to the shape of a future governing majority, although the process of forming a new government may take many weeks.
Current results point to only a small number of possible outcomes. An alliance may emerge led by M5S with the centre-left and left. While an anti-establishment coalition of M5S, the League and the other eurosceptic party, Brothers of Italy, looks unlikely, it remains a material risk.
A coalition of PD, FI and others is another possibility. Given that one-third of seats are allocated according to a first-past-the-post principle, it is only once we have the final results that we can judge the possible coalitions. Another election is not out of the question.
Either way, M5S looks set to be a driving force in the government. The party has softened its extreme anti-Europe positions of the past and adopted a more pragmatic approach. It is still calling for a universal income, and the weakening of the latest pension reform may prompt the markets to doubt the fiscal sustainability of such measures.
How will markets react? It is likely that some short-term volatility will ensue, as Italian markets have outperformed so far this year in expectation of a grand coalition between PD and FI.
In the medium term, however, it is likely, in our view, that the market focus will shift from politics back to fundamentals. Italian GDP grew by 1.5 per cent in 2017 – almost double the expectations at the start of the year – and the latest economic data points to a continuation of this trend. In other words, it looks like Italy has finally been able to join the global growth bandwagon, and the results are evident in both government fiscal performance and company results.
Data published last week points to a deficit of 1.9 per cent in 2017 and the first fall in the country’s worrisome debt-to-GDP ratio in years, albeit a small one. The banking sector appears to have put its woes behind it and the banks have restarted lending.
Investment Implications
Will political uncertainty derail the performance of Italian assets? As long as the Italian economic outlook continues to improve, there is a good chance that the markets will continue to focus on the positive factors that have supported Italian assets in recent quarters. These include the continued support in bond markets from the European Central Bank and a more favourable European institutional framework, especially now that a grand coalition government has been agreed in Germany.
But the process of forming a new government in Italy could take many weeks. What’s more, the resulting political uncertainty may test the patience of the markets. Any coalition that emerges is likely to be less reformist and less focused on austerity. A failure to address Italy’s weaknesses in the short term could leave longer-term fault lines.
As eurosceptic parties are likely to be part of any coalition, the political backdrop is a headwind for Italian treasury bond (BTP) spreads and may provide an obstacle for French president Emmanuel Macron’s eurozone reform agenda.
The political class should be careful not to waste the opportunities that the current phase of synchronised global growth offers the country.
Neil Dwane, Global Strategist, Allianz Global Investors
