Italy’s Right-Wingers Spook Markets Less Than UK

The dust settles on the election victory of Giorgia Meloni, who is poised to lead Italy’s most right-wing government since Mussolini as part of a coalition opponents say is a gift to Vladimir Putin.

But it is Britain’s ‘trussonomics’ that triggered the larger sell-off in financial markets, which, bizarre as it may seem, is a telling indicator of where today’s business radicals sit.

While Meloni’s Euroscepticism and her proximity to Hungary’s strongman Viktor Orban make some European leaders nervous, she maintains the stance of her predecessor Mario Draghi on support for Ukraine and budget commitments. The tango of coalition politics and the constraints of European Union tax rules have kept investors from panicking in the face of an economic platform that includes tax cuts and a bridge to Sicily – despite a potential cost of up to 3.9% of gross domestic product, it said Barclays Plc.

The spread between Italian and German government bond yields — known in Italy as the “lo spread” — has widened but remains narrower than it was during the pandemic or when populists last came to power in 2018 and promised to free speculators in the bond markets fight. Meloni is expected to favor culture wars over economic wars.

Compare that to the response to tax cuts and reforms costing £161 billion ($172.8 billion), or about 6.5 per cent of GDP, under Liz Truss – whom Meloni sees as a role model. UK Gilt yields have edged past Italy. Mortgage deals are snapped. The pound has tumbled against the US dollar and the euro, with economist Olivier Blanchard noting that the European single currency should be happy Britain never joined. Truss risks looking less like Margaret Thatcher and more like François Mitterrand.

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Markets are capable of irrationality, and Italy is also capable of nasty surprises. But there is logic here.

Italian political crises have become a habit, and investors feel they have the measure of Meloni’s playbook. Today’s Eurosceptic politicians have learned from failed attempts to bring about their own Brexit or simultaneously wage a budget war in Brussels and the bond markets. “Giorgianomics” may still be an unfamiliar term, but it leans toward negotiation rather than confrontation — or Italexit.

EU institutions such as the European Commission and the European Central Bank have also expanded their range of instruments and created more guard rails against furniture throwers. The austerity mantra fueling populist anger has been tempered with 191.5 billion euros ($183.8 billion) worth of pandemic recovery funds for Italy’s economy, provided the targets and reforms are met. And Christine Lagarde’s crew has signaled their support for the euro with a bond-buying tool designed to prevent spillover risks – again provided eligible countries comply with post-pandemic commitments.

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The UK is neither Italy economically nor politically, but it offers a cautionary tale on the market as it unleashes economic struggles that even populists in Rome would prefer to avoid. Chancellor of the Exchequer Kwasi Kwarteng’s announcement of large, unfunded tax cuts in a medium-sized open economy, especially in times of 10% inflation and 2.25% interest rates, is an invitation to sell, even taking into account the UK’s relatively lower debt. As Dan Hanson of Bloomberg Economics notes, the parallels to the early 1970s – when a “growth spurt” eventually fueled inflation and currency depreciation – are hard to overlook. International politicians complete the plan.

Here the need to fight “the Left” spills over into the markets. The hunt for a Brexit dividend in an already unregulated economy has exhausted markets’ patience; Kwarteng’s abolition of an EU-era bonus cap for bankers didn’t even excite bankers. The more relevant Brexit effect has been post-2016 sterling weakness, more trade barriers, a loss of European labor force which has tightened labor markets and higher post-pandemic inflation. As economic ideas become more radical, it reflects the need for Brexit victories that prove Britain’s state of emergency. “We came out of Europe and did nothing,” says hedge fund manager Crispin Odey, a Brexit supporter who has also bet on the pound falling.

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All of this is made worse by an open conflict between the UK government and the Bank of England, which appears diametrically opposed to the ECB’s earlier “whatever-it-takes” philosophy. The Truss Tories literally want to step on the gas while the central bank wants to step on the brakes, as my colleague Mark Gilbert writes, which could spell disaster.

To be clear, this market dislocation is a snapshot—it doesn’t have to last forever. What economist Nobel laureate Paul Krugman has dubbed Britain’s “idiotic risk premium” may be fully priced in. Meloni’s coalition government is still a blank slate. Unless Italy’s budget deficit improves, UBS Group AG believes Italy’s debt ratio could rise to 162% by 2027.

But if even the UK can become an Italian-style market destination, that’s a warning no one will soon forget.

This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.

Lionel Laurent is a Bloomberg Opinion columnist covering digital currencies, the European Union and France. He was previously a reporter for Reuters and Forbes.

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