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

MILAN/LONDON, Sept 26 (Reuters) – Italy’s right-wing bloc should have a solid majority in both houses of parliament after Sunday’s elections, potentially giving the country a rare chance for political stability after years of upheaval and fragile coalitions.

Giorgia Meloni, leader of Italy’s nationalist Brothers, is expected to become Italy’s first female prime minister to head the right-most government since World War II.

The lack of anti-euro rhetoric seen in the 2018 election had reassured investors ahead of the vote. A poor result from 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 rising energy prices, war in Ukraine and renewed slowdown in the eurozone’s third largest economy.

As markets closely monitor, let’s take a look at five key questions on the radar.

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

Possibly. Meloni’s comments during the election campaign that she would respect EU fiscal rules reassured markets, and a slight underperformance by Italian bonds on Monday could be as much a result of global market turmoil as a reaction to the outcome.

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

But pressure on bonds could increase as the focus shifts to fiscal policy in 2023. Despite Meloni’s soothing tone, concerns about a possible clash with the European Union could grow as right-wing parties push for lower taxes and higher pension spending.

Nor is there evidence that the right is gaining a two-thirds majority in both houses of parliament that would allow the constitution to be amended without a referendum, which could have caused some fear as the constitution protects issues related to Italy’s EU membership.

“We do not expect an immediate push for major fiscal easing, but we see medium-term risks that the political agenda of the right will collide with EU goals,” said Citi economist Giada Giani.

“Meloni’s first major decision will be the appointment of finance minister, with a pro-European, fiscally cautious figure appearing a likely choice for now,” she added.

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, 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 ($18.3 billion) worth of funds, or 1% of GDP, at risk, Rabobank economist Maartje said Wijffelaars before the vote. Continue reading

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. This ratio is expected to fall this year but could still rise if payments from EU funds fall short and hurt economic growth.

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

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

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.

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

5/ What do the results mean for Italian banks?

The sector is in better shape than it was at the time of 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. Depressed valuations, rising interest rates and Meloni’s reassuring pro-EU comments also mean Italian lenders look attractive, analysts and investors say.

But the economic outlook will eventually prevail and with recession risks mounting, bets on banks could be risky. Italian bank stocks (.FTITLMS3010) outperformed euro zone banks (.SX7E) early Monday.

Reporting by Danilo Masoni, Stefano Rebaudo, Sara Rossi and Alessia Pe in Milan, Yoruk Bahceli in Amsterdam and Dhara Ranasinghe in London, editing by Kirsten Donovan

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