Economic Insight: Italy Election Watch: Limited downside, limited upside

  • Will Italy turn Eurosceptic in 2018? In Italy’s upcoming parliamentary election in spring 2018 half of the electorate is likely to cast their vote for a Eurosceptic political party. Nevertheless we view the probability of a Eurosceptic government emerging as remote. An outright majority for any single populist party is clearly out of reach. In addition the recently adopted electoral law favors pre-election alliances and hence weakens the relative position of the stand-alone Five Star Movement.

  • No Italexit, no problems? The threat of anti-EU, populist forces coming to power in Italy is receding. However we continue to worry about the rising political fragmentation. A hung parliament is all but certain allowing only for difficult coalition dynamics. Our baseline scenario envisions the formation of a ‘grand coalition’ government headed by a united centre-right camp and including Matteo Renzi’s Democratic Party as a junior coalition partner. The chances of such heterogeneous, ill-suited coalition partners agreeing on an ambitious reform agenda are slim.

  • How will markets react to political uncertainty? Rather than a tectonic shift the 2018 election looks set to deliver ‘more of the same’ with Italian politics having long been characterized by uncertainty and instability. Hence we don't expect market confidence towards Italy to decline markedly with the robust macroeconomic backdrop in Europe propping up investor sentiment. Moreover even in an adverse scenario the negative impact of elevated financial market stress on public finances would be mitigated by Italy’s favorable debt structure including a low average interest rate, a long average maturity and a strong domestic investor base.

  • The long view: Italy remains the eurozone’s Achilles heel. If in the medium term Italy is unable to generate growth to address its many fundamental problems, from high public debt to a fast aging population and an undercapitalized banking sector, this will represent a considerable challenge for the eurozone, economically as well as politically.