Italy’s right-wing bloc set for election win: five questions for markets

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MILAN, Sept 19 (Reuters) – Italy’s right-wing bloc is likely to win a majority in both houses of parliament in next Sunday’s elections at a time when rising energy prices and rising interest rates are posing mounting challenges to the heavily indebted state.

Giorgia Meloni, leader of Italy’s nationalist Brothers, is seen as a pioneer on the road to becoming Italy’s first female prime minister. She said the right-wing bloc would respect the European Union’s budgetary rules but called for reforms. Continue reading

The lack of anti-euro rhetoric in the 2018 election has reassured investors for now.

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“In the short term, we’re reassured, but that’s short term,” said Charles Haddad, portfolio manager at OFI Asset Management.

Here are five key questions for the markets.

1/ How will the markets react to a right-wing victory?

The near-term reaction may be muted as a centre-right victory is expected. At around 225 basis points, the closely watched gap between Italian and German 10-year bond yields has been relatively stable.

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But pressure on bonds could increase as the focus shifts to fiscal policy in 2023. While Meloni has spoken about complying with EU budget rules, concerns about a possible conflict could grow as right-wing parties push for lower taxes and higher pension spending.

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And if the right wins a two-thirds majority in both houses of parliament, the constitution could be changed without a referendum. That would create some fear as the constitution protects issues related to Italy’s EU membership.

Any new government will have little leeway to roll back reforms or pursue “unorthodox” economic policies due to political and market pressures, Scope Ratings warned in a recent report. Continue reading

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2/ Could Italy’s EU funding plan be changed?

The brothers of Italy see scope for a change in the EU-backed program of Italy’s recovery fund to take account of the energy shock. Continue reading

To receive the next tranche of funds in December, Rome must meet 55 new targets in the second half of 2022, which a party official said should be adjusted. Brussels has said only fine-tuning of the agreed recovery plan is possible. Continue reading

The party has said it will not jeopardize access to the scheme, but changing plans could put 19 billion euros ($18.93 billion) worth of funds, or 1% of GDP, at risk, Rabobank economist Maartje said Wijffelaars. Continue reading

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3/ What does a new government mean for Italy’s debt?

With a debt ratio of 151% to gross domestic product, Italy is one of the most indebted countries in the world.

The debt-to-GDP ratio, which is expected to fall this year, could rise if payments from EU funds fall short and weigh on economic growth.

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Concerns over Italy’s debt have pushed 10-year bond yields up to 4%. Moody’s and S&P lowered their outlook for Italy’s rating after Mario Draghi resigned as prime minister in July. Continue reading

“I hope the first warnings we’ve already seen (from rating agencies) aren’t a harbinger of something bad for the country rating, as it would mean real trouble for whoever is running the country,” said Alessandro Tentori, CIO at AXA Investment Managers Italy.

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

Rising borrowing costs in debt-ridden Italy are testing the ECB’s resolve to contain bond market tensions.

Italy’s election was seen as a short-term obstacle to the ECB activating its Transmission Protection Instrument (TPI) – a new tool to prevent weaker sovereigns’ borrowing costs from drifting too far from top-rated Germany through no fault of their own.

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The ECB is not expected to use the TPI any time soon, but its presence should help support Italian bonds. Continue reading

“We should not underestimate the ECB’s willingness to avoid fragmentation,” said Amundi Group Chief Investment Officer Vincent Mortier, adding that a move in bond spreads towards 300 basis points would be a “buy signal” for Italy.

5/ What do the results mean for Italian banks?

The sector is in better shape than it was in the 2018 election, when anti-euro rhetoric from populist parties unsettled investors.

Italian banks have a stronger capital base and are less subject to government pressure than they were a decade ago. Cheap valuations, rising interest rates and Meloni’s reassuring pro-EU comments make Italian lenders attractive.

But the economic outlook will ultimately prevail and amid rising recession risks, betting on banks is risky, analysts say.

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($1 = 1.0036 euros)

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Reporting by Danilo Masoni, Stefano Rebaudo, Sara Rossi and Alessia Pe in Milan, Yoruk Bahceli in Amsterdam and Dhara Ranasinghe in London, editing by Tommy Reggiori Wilkes and Susan Fenton

Our standards: The Thomson Reuters Trust Principles.

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