European election series: Part 3 of 4

Editor’s note: This is the third in the blog series about the forthcoming European elections. Follow the series and watch for the final post that discusses the upcoming French Presidential Election.

Italian elections – uncovering the risks

Italy stands out in the Euro area for the significant support it gives to its anti-Euro populist parties. Together, their voter support broadly equals that for Italy’s centrist parties. While Italy is not due to hold elections until May 2018, since voters voted “no” in December’s referendum on constitutional reform and Prime Minister Renzi resigned, there has been speculation that Italy could hold the election this year. The earlier the election, the greater the chances of a populist party victory.

The two largest parties in Italian politics are currently the Democratic Party (PD) and the anti-establishment Five Star Movement (M5S) party. Recent polls show that while the PD party has the most support among voters, scoring around 30%, anti-Euro M5S is only just behind and certainly too close for comfort. If the elections were held now, M5S would have a reasonable chance of coming first.

Despite this risk, the leader of the Democratic Party, former Prime Minister Renzi, had been flirting with the idea of calling an early election, going so far as to seek approval from the PD to hold a general election in June 2017. However, the majority of the party’s members and ministers of parliament (MPs) oppose this option, instead favoring elections in 2018 when the current government’s term ends. Faced with a loss of support within his party, in February Renzi decided to step down as PD leader. He has called for a new congress, to be held in late April 2017, to elect his successor – in which case he will run himself and likely win. Essentially, then, Renzi’s decision to resign as leader was a simple strategy to reaffirm his support and thereby push forward with his policy agenda.

Unfortunately, the PD party’s decision to call for an early congress to vote in a new leader has also caused the party to split into two different political entities: the Democratic Party (PD) and the Democratic & Progressive (DP) party. The new left-leaning DP party represents only a small minority, removing about 3% of support for PD (according to polls). However, given the very thin margin of support that PD holds over M5S, that 3% could be meaningful – particularly if elections are held within the next couple of months.

Italian politics: never simple

The Italian electoral system has been the focus of much attention, as its previous structure slightly increased the chances of a market-unfriendly outcome. The key features of the revised electoral system is that in a general election, there will be only one round of voting (there were previously two rounds, which had strongly increased the chances of an outright populist party victory) and if any party wins more than 40% of the vote, it will be awarded a “supermajority” of seats (for more details, please see Italy: the political risks pile up). Given the fragmented nature of Italian politics, it is unlikely that any one party will reach the 40% threshold that would result in it being awarded a “supermajority.” As a result, the Italian electoral system will tend to be proportional and coalitions are likely.

The implication is that if M5S won the most votes, it would likely need to forge a coalition to form a government. Unfortunately, this no longer provides much comfort. There have been reports that M5S has been discussing a possible post-election coalition with two other populist parties: the Northern League (NL) and Brothers of Italy (BoI). Although the three parties tend to be on different sides of the political spectrum on most policies, and M5S has never officially been open to this possibility, they all share one significant agenda: all three parties are against Italy’s membership of the euro. Together, they poll around 45% and could reach an outright majority under an anti-Euro manifesto – the nightmare scenario for Italian politics. While we would only assign a small probability to this scenario, the risks associated with a M5S victory are clearly significant.

The later, the better

Crucially, however, the likelihood of an early election has diminished sharply. The decision to hold the new congress in April leaves insufficient time to prepare for a new general election in June. After all, a general election cannot be called before a party has elected its leader and, to have an election in early June, the Parliament would need to be dissolved by mid-April. Thereafter, the summer recess will begin. There is still a chance that Renzi will push for elections in Q4 2017, but this would still be met with resistance from PD MPs who want to wait until 2018.

A later election is important. It is possible that recent scandals and its poor performance in the administration of Rome will gradually reduce support for M5S. At the same time, the economic story has been improving, albeit very gradually. The Italian economy grew 1% in 2016, business surveys have been picking up, and Unicredit recently tapped the market for €13 billion in a share issue – a successful implementation of its recapitalization plan. Stronger market conditions tend to benefit traditional parties over populist ones.

Developments in the elections in the Netherlands, France, and Germany should also support the PD. The failure of the populist Freedom Party (PVV) to win the most votes in the Dutch election, together with the likely victory of a centrist candidate (Fillon or Macron) in the French Presidential elections could take some shine off Italy’s populist parties. In addition, a victory by Martin Schulz in the upcoming German elections would likely lead to a more sympathetic approach to the European peripheries, also strengthening support for Italy’s traditional parties.

Will the true market risk please stand up

Renzi’s decision to step down as PD leader means that the next Italian general election is likely to be held in 2018. Of course, while this improves the chances of a centrist party victory, the strength of M5S’s support means that there is still a reasonable probability of a populist government. Anything can happen – this is Italian politics, after all.

Italian 10-year bond yields have increased around 40 basis points in the past three months. It could be worse: European Central Bank (ECB) bond purchases under the asset purchase scheme will have put downward pressure on Italian bond yields, suppressing the nervousness of the Italian bond market. Perhaps it is only once the ECB starts to reduce monthly asset purchases, at the start of next year, that the true concerns about Italy will be unveiled.

 

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