As expected, the center-right coalition of parties has as won the Italian elections, but it has not attained a qualified majority, which is necessary to reform the constitution. In fact, the center-right coalition’s share is a simple majority, but owing to the electoral system, it will receive enough posts to control both houses. The new parliament will meet for the first time on 13 October, and with Brothers of Italy (BoI) the leading force, party leader Giorgia Meloni looks set to become Italy’s first female prime minister. Forming a government may take several weeks, although it should be possible to draft the budget by year-end.
But while there has been some speculation that a new center-right government could put Italy on a collision course with the European Commission, at least in its campaign BoI has indicated it will maintain a disciplined fiscal policy. So here is what investors should focus on:
The political landscape has become more pro-European: Euro-skepticism has been notably absent in this political campaign in stark contrast with previous elections. This reflects a shift in public opinion, which now more strongly supports the single currency and a more integrated EU. The incumbent government will present the new fiscal forecasts by the end of September, and the new government should present a budget law to the European Commission by the year-end. With inflation biting and energy prices hitting new highs, all party manifestos propose some form of agenda to alleviate the pressure on both households and businesses. This entails some form of fiscal expansion and a price cap for energy to be agreed on at the European level.
BoI signaled disciplined fiscal policy in the campaign: Despite the expectation of some form of fiscal expansion, we think that the risk of severe slippage in this area is low given political leaders’ statements in the run-up to the elections and the fact that any budget has to be agreed on with the EU. Notably, BoI has pledged a disciplined fiscal policy in its campaign, so this is one of the areas where tensions may arise with their junior partner, Lega (support to Ukraine is another).
Bond investors appear still fairly compensated for risks: Overall, the outcome should be no surprise for markets with some political risk already embedded in Italian assets. Risk premiums for Italian government bonds have more than doubled from their pandemic lows and are trading around 230bps over 10-year German Bunds. We think investors in short- to medium-dated Italian bonds are well compensated for the risks resulting from Italy’s high public debt burden and recurring episodes of political uncertainty.
So we continue to see value for buy-and-hold investors in short- to medium-dated Italian bonds. In light of continued high volatility in both interest rates and risk premiums, we think longer-dated Italian bonds do not yet offer appealing entry levels. Read more on how to manage a Liquidity strategyhere.
For more, see European economy: Italy: Center right coalition ahead in the run up to the elections, 27 September, 2022.