MILAN (Reuters) – Italy’s right-wing bloc appears poised to win a majority in both houses of parliament in next Sunday’s elections at a time when soaring energy prices and high interest rates are creating growing challenges for the debt-burdened country.
Giorgia Meloni, leader of Italy’s nationalist brotherhood, is seen as the frontrunner to become Italy’s first female prime minister. She said the right-wing bloc would respect EU budget rules but called for reforms.
The absence of anti-euro rhetoric in the 2018 elections reassured investors, for now.
“In the short term, we feel reassured, but this is short term,” said Charles Haddad, director of asset portfolio at Ovi.
Here are five key questions for the markets.
1/ How will the markets react to the right’s victory?
The near-term reaction could be muted given that the center-right win is expected. At around 225 basis points, the closely watched gap between Italian and German 10-year bond yields has been relatively stable.
Beware the gap https://graphics.reuters.com/ITALY-POLITICS/lgpdwdgrmvo/chart.png
But the pressure on bonds could increase as the focus shifts to budget policy in 2023. And while Meloni spoke of adhering to EU budget rules, concern about a potential clash could grow if right-wing parties push for lower taxes and higher pension spending.
And if the right wins a two-thirds majority in both houses of Parliament, the constitution can be changed without a referendum. This may cause some concern because the constitution protects issues relating to Italy’s membership in the European Union.
Scope Ratings warned in a recent report that any new government would have little room to roll back reforms or pursue “unconventional” economic policies due to political and market constraints.
Italy’s economic problems https://graphics.reuters.com/ITALY-POLITICS/egpbkrwwdvq/chart.png
2/ Can the EU financing scheme for Italy be modified?
The Italian Brotherhood sees scope for adjusting the Italian EU-backed Recovery Fund program to account for the energy shock.
To receive the next batch of funds in December, Rome needs to reach 55 new targets in the second half of 2022, which a party official said should be revised. Brussels said it was only possible to modify the agreed recovery plan.
Rabobank economist Marty Wijvillars said the party said it would not jeopardize access to the program, but that changing plans could put money worth 19 billion euros ($18.93 billion) or 1% of GDP at risk.
3 / What does the new government mean for Italian debt?
Italy is one of the world’s most indebted countries, with debt as a share of GDP amounting to 151%.
The debt ratio is expected to fall this year, and may rise if EU fund payments fall short, hurting economic growth.
Italy’s ballooning debt https://graphics.reuters.com/ITALY-POLITICS/egvbkrwggpq/chart.png
Concern about Italian debt pushed 10-year bond yields to 4%. Moody’s (NYSE:) and Standard & Poor’s lowered their outlook for Italy’s rating after Mario Draghi resigned as prime minister in July.
“I hope the first warnings we have already seen (from rating agencies) are not a harbinger of something bad for the sovereign, because that will be a real problem for whoever leads the country,” said Alessandro Tintori, CIO of AXA Investment Managers Italy. .
4/ Can the European Central Bank activate the anti-fragmentation tool?
Rising borrowing costs in debt-laden Italy are testing the European Central Bank’s resolve to contain bond market pressures.
Italy’s election was seen as a near-term obstacle to the European Central Bank activating the Transfer Protection Instrument (TPI) – a new tool to prevent borrowing costs in weaker countries from drifting away from top-rated Germany through no fault of its own.
The ECB is not expected to use the Selling Price Index soon, but its presence should help support Italian bonds.
“We should not underestimate the ECB’s desire to avoid fragmentation,” said Vincent Mortier, chief investment officer at Amundi Group, adding that a move in the bond spread towards 300 basis points would be a “buy signal” for Italy.
5/ What will the results mean for Italian banks?
The sector is in a better position compared to the 2018 elections when populist parties’ anti-euro rhetoric rattled investors.
Italian banks have a stronger capital base and are less subject to sovereign pressure than they did a decade ago. Cheap valuations, high rates, and Meloni’s reassuring EU-friendly reviews also mean Italian lenders look attractive.
But analysts say the economic outlook will eventually dominate, and with the risks of a recession growing, betting on banks is risky.
Italy’s economic problems https://graphics.reuters.com/ITALY-POLITICS/lgpdwdgakvo/chart.png
(1 dollar = 1.0036 euros)