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Italy's right-wing bloc wins election: five questions for markets

Economy Sep 26, 2022 06:13AM ET
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2/2 © Reuters. A paper sits on a table with the headline that reads: "Giorgia Meloni won", a day after the snap election in Rome, Italy, September 26, 2022. REUTERS/Guglielmo Mangiapane 2/2
 
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MILAN/LONDON (Reuters) - Italy's right-wing bloc should have a solid majority in both houses of parliament following Sunday's election, potentially giving the country a rare chance of political stability after years of upheaval and fragile coalitions.

Giorgia Meloni, leader of the nationalist Brothers of Italy, looks set to become Italy's first woman prime minister at the head of its most right-wing government since World War Two.

The absence of the anti-euro rhetoric seen in the 2018 election had reassured investors in the run-up to the vote. A poor result for Matteo Salvini's League, the party with the least pro-European stance, could also be a relief.

However, Meloni and her allies face a daunting list of challenges, including soaring energy prices, war in Ukraine and renewed slowdown in the euro zone's third largest economy.

With markets watching closely, we take a look at five key questions on the radar.

1/ Is the prospect of political stability a positive for markets?

Possibly. Meloni's comments during the election campaign that she would respect EU budget rules reassured markets and a slight underperformance by Italian bonds on Monday could be due as much to global market unease than a reaction to the result.

At around 230 basis points, the closely watched gap between 10-year Italian and German bond yields has been relatively stable.

But pressure on bonds could build as focus shifts to budget policy in 2023. Despite Meloni's reassuring tone, concern about a potential clash with the European Union could grow if right-wing parties push for lower taxes and higher pension spending.

Also, the right is not seen wining a two-thirds majority in both houses of parliament that would allow the constitution to be changed without a referendum, which could have caused some angst since the constitution protects issues related to Italy's EU membership.

"We do not expect an immediate push for a major fiscal relaxation, but we do see risks over the medium term that the right's policy agenda will clash with EU objectives," said Citi economist Giada Giani.

"Meloni's first key decision will be the appointment of the finance minister, with a pro-Europe, fiscally-cautious personality looking a likely choice for now," she added.

2/ Could Italy's EU funding plan be modified?

The Brothers of Italy sees room to amend Italy's EU-backed recovery fund programme to account for the energy shock.

To receive the next tranche of funds in December, Rome needs to meet 55 new targets, which a party official has said should be adjusted. Brussels has said only a fine-tuning of the agreed recovery plan is possible.

The party has said it won't jeopardise access to the programme but changing plans may put the funds, worth 19 billion euros ($18.3 billion) or 1% of GDP, at risk, said Rabobank economist Maartje Wijffelaars before the vote.

3/ What does a new government mean for Italian debt?

Italy is one of the world's most indebted states, with debt as a share of gross domestic product at 151%. That ratio is expected to fall this year but could yet rise if EU fund payments fall short, hurting economic growth.

Concern about Italian debt has pushed 10-year bond yields above 4%. Moody's (NYSE:MCO) and S&P cut their outlook for Italy's rating after Mario Draghi quit as Prime Minister in July.

"We expect a rather muted market reaction in terms of BTPs credit spread in the short term, as the election outcome was broadly in line with expectations," said UniCredit strategists, adding that some short covering was also possible.

4/ Could the European Central Bank activate its anti-fragmentation tool?

Rising borrowing costs in highly-indebted Italy are testing the ECB's resolve to contain bond market strain.

Italy's election had been seen as a near-term obstacle to the ECB activating its Transmission Protection Instrument (TPI)- a new tool to prevent weaker states' borrowing costs diverging too far from top-rated Germany through no fault of their own.

The ECB is not expected to use the TPI 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 at the time of the 2018 election when populist parties' anti-euro rhetoric rattled investors.

Italian banks have a stronger capital base and are less exposed to sovereign stress than they were a decade ago. Cheap valuations, rising rates and Meloni's reassuring EU-friendly comments also mean Italian lenders look attractive, analysts and investors say.

But the economic outlook will ultimately hold sway and with recession risks growing, betting on banks could be risky. Italian banking stocks outperformed euro zone banks early on Monday.

Italy's right-wing bloc wins election: five questions for markets
 

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