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MILAN/LONDON (Reuters) – Italy’s right-wing bloc should have a solid majority in both houses of parliament after Sunday’s elections, which could give the country a rare chance for political stability after years of turmoil and fragile alliances.
Giorgia Meloni, the leader of the Italian nationalist Brotherhood, appears poised to become Italy’s first female prime minister at the head of the most right-wing government since World War II.
The absence of anti-euro rhetoric seen in the 2018 elections reassured investors in the run-up to the vote. The poor result of Matteo Salvini’s League, the least pro-European party, could also be a relief.
However, Meloni and her allies face a daunting list of challenges, including rising energy prices, the war in Ukraine, and a renewed slowdown in the eurozone’s third-largest economy.
With the markets closely watched, we take a look at five key questions on the radar.
1/ Is the prospect of political stability positive for the markets?
Probably. Meloni’s comments during the election campaign that she will respect EU budget rules have reassured markets and that the slight weak performance of Italian bonds on Monday may be due more to global market unease than reaction to the outcome.
At around 230 basis points, the closely watched gap between Italian and German 10-year bond yields has been relatively stable.
But pressure on bonds could increase as the focus shifts to budget policy in 2023. Despite Meloni’s reassuring tone, concern about a potential clash with the EU could grow if right-wing parties push for tax cuts and increased pension spending.
Also, the right was not seen 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 some concern as the constitution protects issues related to Italy’s EU membership.
“We don’t expect an immediate push for significant fiscal easing, but we see medium-term risks that the right-wing policy agenda will conflict with EU objectives,” said Giada Gianni, an economist at Citi.
“The first major decision Meloni will make will be to appoint a finance minister with a pro-European and fiscally prudent figure that appears to be a possible option at the moment,” she added.
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 meet 55 new targets, 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 before the vote that the party had said it would not jeopardize access to the program, but that changing plans could put money worth 19 billion euros ($18.3 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%. This ratio is expected to decline this year but could rise if EU fund payments fall short, hurting economic growth.
Concern about Italian debt has pushed 10-year bond yields to more than 4%. Moody’s (NYSE:) and Standard & Poor’s lowered their outlook for Italy’s rating after Mario Draghi resigned as prime minister in July.
“We expect a weak market reaction regarding the short-term BTPs credit spread, as the election result was broadly in line with expectations,” said UniCredit strategists, adding that some short-covering was also possible.
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.
5/ What will the results mean for Italian banks?
The sector is in better shape than it was 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 subject to sovereign pressure than they did a decade ago. Cheap valuations, high interest rates and Meloni’s reassuring EU-friendly comments also mean Italian lenders look attractive, analysts and investors say.
But the economic outlook will eventually dominate, and with the risks of a recession growing, betting on banks can be risky. Italian bank stocks outperformed euro zone banks early Monday.
