Italian election may herald another chapter in the Eurozone crisis

27th February 2013

Fund managers are warning that the Italian election result could open up a new chapter in the eurozone crisis as the overwhelming majority vote against austerity. Experts are even warning there is a chance of an Italian referendum on EU membership.

Political uncertainty until mid March

Jack Kelly, Standard Life’s investment director for global government bonds says that uncertainly will continue until at least mid March and that we may see another uneasy compromise between the left and right political groups with Bepe Grillo’s 5 Star movement standing apart.

Kelly adds: “The Italian elections have prompted a fresh bout of uncertainty in European bond markets with peripheral spreads widening sharply on the inconclusive result. The most likely development from here will be an uneasy compromise between Pier Luigi Bersani’s centre-left and the centre right to agree to a loose grand coalition in order to avoid another election and stall the momentum gained by Beppe Grillo’s Five Star movement. This will be a fraught process and we are unlikely to get clarity until at least March 15th when the Houses are scheduled to meet.”

Derry Pickford, macro analyst at fund managers Ashburton says it means the overwhelming majority of Italians voted against austerity. He gives a detailed assessment of the electoral arithmetic below.

Election arithmetic

“In the vote for the lower house, Comedian Beppe Grillo’s Five Star Movement (5SM) got the biggest share of any single party at nearly 25.6 per cent of the vote. However, 5SM was behind Bersani’s “Common Good” coalition of social democratic socialist and green parties, which totalled 29.6 per cent, and Berlusconi’s coalition of conservative nationalist and regional parties at 29.2 per cent. This meant that the majority of Italians voted against austerity. The only group advocating pure ECB orthodoxy, Monti’s centrist coalition, got 10.6 per cent of the vote. Bersani takes the lower house by virtue of leading the biggest coalition (54 per cent of seats automatically go to the largest coalition regardless of the margin of victory). Although both Bersani and Berlusconi did marginally better in the share of the Senate vote, Bersani failed to get a controlling majority either alone or with Monti’s centrists. This will make formation of a new government tricky. The best case for Bersani is that he is able to build a grand coalition; the worst is that we get yet more elections and that Berlusconi and Grillo win a majority. An alternative scenario is that Bersani may be able to tempt some members of the 5SM with promises of reforms that tackle corruption and vested interests as well as improved internet infrastructure.”

Standard Life says that while the whole approach of the European Central Bank has introduced measures to give countries time to reform that does not take into account the rise of protest and anti-establishment parties across Europe.

Kelly says: “Of course Italy is used to unstable government and the immediate downside for Italian bond spreads is capped by the potential activation of ECB support in one form or another. However, we are of the view that the Euro-zone crisis is set to continue, and that recent excessive optimism has been misplaced as the underlying causes of the crisis have not yet been properly addressed. The European financial system is still dysfunctional, with credit not flowing to intended recipients. The absence of Eurobonds still prompts uncertainty over peripheral sovereign debt.”

“What this episode does again underline is that while the ECB is trying to buy time for governments to enact reform, the environment of continued enforced austerity and low growth leads to a more fractious political scene, with the rise of protest and anti-establishment parties across Europe. We are positioned underweight in the periphery and underweight the Euro in our bond funds.”

Could there be an in-out referendum?

Standard Life Investments Head of Global Strategy Andrew Milligan says: “At the very least, a prolonged period of uncertainty faces the Italian economy, affecting investor sentiment. In coming months, fiscal slippage and obstacles to structural and labour market reforms would not at all be well received by global investors. Investors have to think about tail risks. The probability is low, but not negligible, that Italy will have a referendum on EU membership before this political crisis comes to an end.

“Only about 1 in 10 Italian voters, on a low turnout of 75%, actually supported Monti, the politician whose policies are closest to the European mainstream. Despite the political furore about the UK losing its AA status, it should be remembered that, for example, Standard & Poors rates Italy BBB+ with a negative outlook.”

Pickford adds: “Both Grillo and Berlusconi have flirted with the idea of a referendum on Italy’s membership of the Euro and this is what really scares markets. Any question about Italy’s commitment would raise “convertibility” premia. This should mean that the ECB would step in with Outright Monetary Transactions (OMT) but OMT is conditional on Italy following a path of fiscal consolidation. This could set up a dangerous game of chicken between a future Italian administration and the ECB, with Merkel on the other side. So far, European policymakers have managed to avoid disaster and we still think they will do the right thing eventually, but in the mean-time markets could have a real fright.”

16 thoughts on “Italian election may herald another chapter in the Eurozone crisis”

  1. Pavlaki says:

    Very interesting topic and one I wouldn’t pic up elsewhere. I think your comments a while ago on why the Euro remains strong we’re spot on. Reports to day that Asian Central banks buying Euros on the dips hence supported at E1.37 to the dollar when it should have gone lower. Very frustrating for Mr Draghi as his attempts to talk the value down are frustrated unless backed by action.

    1. Anonymous says:

      Hi Pavlaki

      I was in a dealing room on Thursday for the ECB press conference and for all the talk of Euro selling on the squawk boxes it didn’t go far. Then yesterday the German newspaper FAZ wrote that the ECB had been modelling the effect of 1 Trillion Euros of QE. Actually the reporting got muddied as if it is private assets then it is more credit easing than QE but whichever it was another hint at more stimulus. And the Euro well it closed at 1.3702 this weekend…Plus ca change.

  2. dutch says:

    And there was me thinking the BRIC’s were about to decouple.

    Any details on M2 velocity Shaun?

    Furthermore,I’ve alwyas taken the velocity figures at face value.Do you know how they’re calculated and where I could learn more about it please?

    1. Anonymous says:

      Hi Dutch

      That is a question which is where theory diverges from practice. The original MV=PT has 2 usually unknown numbers. Ooops! Accordingly T (Transactions) tends to get replaced with output.

      If I now do the maths for Russia we have the problem that the real output figures are behind events. Awkward (timing and data availability is always a big issue in econometrics) but if we plough on and assume the Russian economy is flat right now then we arrive at M2 velocity have fallen by 5% over the past year. Caveat Emptor etc..

      The St. Louis Fed does a data series for it in the US.

      https://research.stlouisfed.org/fred2/categories/32242

      1. dutch says:

        Velocity is a ratio of nominal GDP to a measure of the money supply (M1 or M2).

        1. dutch says:

          that was from you link shaun.thank you.

  3. Midge says:

    Hi Shaun and thanks for this blog as the media only seem to mention frozen assets and travel restrictions for a few Russians close to Mr Putin.
    This looks like stagflation which will not abate for sometime whatever the propaganda might say.
    The people in Russia will be badly hit by rising food prices and I understand unemployment benefits are not high.
    As far as the ECB is concerned it seems paralysed to take action and are hoping for the best.What action might it take? You have blogged on this recently and any option is not certain of a positive outcome you concluded.The Euro has fallen back a little as of the last couple of days which will give Mr Draghi hope but as Nouriel Roubini has blogged do not expect European QE any time soon.

    1. Anonymous says:

      Hi Midge

      The ECB is trying open mouth operations at the moment. As the statement I mentioned above in the press conference affected the media much more than the foreign exchange market it seems to have leaked plans for 1 Trillion Euros of what is called QE but seems more likely to be credit easing to FAZ. But as I replied to Pavlaki the Euro closed for the weekend at 1.3702..

      The actual gain has been in bond yields which have dropped including the German Bund so perhaps Mario Draghi is playing “Jedi Mind Tricks” like he did with the OMT programme. The catch is that these benefit the financial economy much more than the real one.

  4. Pavlaki says:

    My earlier comment posted before I had finished – fat finger syndrome! I was going to ask what you thought of the ECB considering buying a trillion Euros of bonds? I assume they mean corporate bonds as sovereigns would be vetoed by Germany. It would cause market distortion. I would have thought it better to devalue the Euro through negative rates and that would import inflation to achieve their goal?

  5. Anonymous says:

    Hi Shaun,

    You have previously described a disconnect between BOE rates and consumer loan rates. The Russian Central bank has little control over events – the Brent crude price is outside it’s control. Commodities are cyclical, the Breznev doctrine combined with high oil prices, and the low oil prices of the 1990s could have driven other Russian leaders besides Yeltsin to drink.

    If Poland starts fracking with American enthusiasm, Gazprom’s monopoly looks busted. There are hydrocarbon/gas resources in the Black sea (Rumania/Bulgaria), and offshore Greece & Cyprus.

    Russia’s overcharging and bullying of Ukraine is ringing alarm bells and has Eastern Europeans working very hard to locate other gas supply options, which could decimate Russian export earnings. New oil wells are opening in Iraq, increasing supply – which traditionally puts downward pressure on prices.

    The Russian central bank’s base rate means little when gas & oil commodities plunge.

    1. Anonymous says:

      Hi ExpatInBG

      The resources economies (Russia,Canada and Australia) all face the problem that they are small boats with only a small engine in a large economic ocean. Until now the credit crunch era has favoured them as resources have been in demand but any dip would be punishing and one by one they are seeing elements of this.

      The other side of the coin is Forbin’s argument that fracking needs a highish oil price to be viable so there is a lock on the price. But of course Russia could find it has orders for less quantity at that price going forwards..

      As to the Bank of Russia I completely agree that the list of things it can control is much shorter than the ones it cannot.

      1. Anonymous says:

        Fracking may be expensive, But capitalist, competitive America has cheap fracked gas on sale and the ex-SOE monopoly Gazprom sells expensive non-fracked gas to the EU.

  6. Anonymous says:

    Great column, Shaun. The Central Bank of Russia had raised the target rate of inflation in September from 4.5% to 5% for 2014. I am sure they didn’t see the Crimean takeover coming at that time. Just the same, if inflation is now running at more than 6% one does wonder at the wisdom of an inflation-targeting central bank raising its target rate. As you would say: To infinity and beyond! Andrew Baldwin

  7. Anonymous says:

    Hi Chris

    Other minds are clearly thinking along the same lines as you as I have seen suggestions that Ukraine should raise the price of the food it sells to the Crimea. As to the currency war argument that is intriguing. Do you mean an actual war or that the current skirmishes push the Rouble lower and hence give Russia a competitive advantage? (At least until the inflation erodes it…)

  8. Anonymous says:

    Sounds like an opportunity for Poland to buy gas and re-export to Ukraine …

  9. Anonymous says:

    Shaun,
    I think the gloves are off letting currency devaluation cause pain in Russia to reduce support for Putin’s actions and ambitions. Also shows US dollar importance in gas sales for now at least that Russia has to live with.

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