Let's start with the good news. A victory for Luigi di Maio, the designated candidate for the Five Star party (M5S) – undoubtedly the worst-case scenario for equity markets, Italian bonds, and the single currency – seems highly improbable.
This is principally because his party does not want to form an alliance with its counterparts. And the feeling is mutual: the other parties do not want to band together with Five Star either. Not only does di Maio lack 7-10 per cent of the national vote, but, moreover, the centre-right is likely to grab the majority of districts.
Even with a victory for the M5S party, a minority government led by M5S has very little chance of seeing the light of day, as the current electoral system favours coalitions – which would likely lead the president of the Republic to mandate a representative of the leading centre-right rather than the leading party.
We also dismiss the scenario of an anti-establishment government, formed by M5S, FI and LN. While possible in theory, given the gains achieved by each of these parties, in practice, there is a great deal of dissension between each party. Moreover, reconciliation would lead to a loss of popular support, as it would go against the very principles of M5S and its successful standpoint: ‘neither right, nor left’.
‘Small majority' would create longer-term difficulties
According to the latest polls, a centre-right coalition is not far from obtaining a majority – it lacks between 20 and 50 seats. In the event this shortfall drops to less than 20 seats, it could lead to the crossover of some ‘centrist’ parliamentarians from the left wing or desertion in other minor parties.
This ‘small’ majority would lead only to a small increase in Italian equities, as well as a reduction in the spread between Italian and German bonds and a slight increase in the euro in the short term. This is because a small majority would lead to longer-term instability.
We expect this scenario would increase tensions linked to the possibility of further elections in the next 6-12 months.
Coalition of centrists: a new hope
There is a possibility none of the parties or coalitions obtain a clear majority. We would most likely see a slight negative reaction from markets in the first instance, but not a sense of panic, since on the one hand Paolo Gentiloni would remain at the helm and, ultimately, if the centre-right and centre-left parties join forces, that would certainly be the best possible scenario.
If the far-right parties, and the far-left parties to a lesser extent, were abandoned or marginalised, this would lead to a new wave of hope, similar to that witnessed after the victory of Emmanuel Macron's party in France. Here, too, we have to count on the crossover of some parliamentarians to ensure the majority. And here, too, a large coalition does not necessarily mean a strong and cohesive one.
For the moment, the centre-right coalition seems to be the most likely outcome, but the possibility of a large coalition could very quickly become a real probability, if the scores obtained by the far-right parties turn out to be lower than expected.
‘Better ungoverned than badly governed’
If it proves impossible to form a government, there will be further elections held 6-12 months from now. The negative impact will be marginal and short-lived. The draft budget will be affected, but ultimately, would it be such a great surprise if Italy, which has had 62 governments since the end of World War Two, does not have a proper government in place for a few months? Have Belgium or Spain, which have seen similar situations in the past, come out worse for wear? Maybe sometimes it's better to be ungoverned than badly governed.
More than any other major eurozone country, Italy needs to put structural reforms in place to try and dilute, as quickly as possible, its dangerous cocktail of low growth and booming public debt. But most Italians are not fooled, since the worst-case scenario in terms of an explosion of public debt, namely a unilateral victory by Lega Nord, Liberi e Uguali, or the Five Star Movement, is not foreseeable.
For the rest of the players, Matteo Renzi's Democratic Party (PD) plans to maintain the status quo in terms of fiscal policy, and the impact of the Forza Italia plan is still difficult to evaluate, as they promise significant tax reductions and a desire to reduce the public debt ratio to 110 per cent in the next five years. We can dream, but Italians do not believe these measures will be implemented any time soon. Unless the winds of change one day blow over Italian politics, like they did in France.
Fabrizio Quirighett is co-head of multi-asset at SYZ Asset Management.
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