Markets jumped all over the place earlier this week following the Italian election result, which saw pre-election poll favourite and leader of the centre-left coalition Pier Luigi Bersani take the lower house by the narrowest of margins, but fail to win enough votes to take the upper house (senate).
This means there is currently no clear winner and the Italian parliament has entered into stalemate, thrusting markets into uncertainty.
The market initially rallied on polls indicating a Bersani victory but then fell on the realisation that the senate was hung. Indeed, the Eurostoxx 50 index closed Tuesday down 3.1% at 2,570.62 – its lowest finish since 28 November.
In the meantime this deadlock leaves investors with the big question of how long markets will suffer. This question is unlikely to be answered until at least 15 March when the houses are scheduled to meet.
Possible outcomes being bandied about are: a grand coalition between the centre left (Bersani) and centre right (Silvio Berlusconi), or a coalition between the centre left and former comedian Beppe Grillo’s Five Star Movement party, some of whose policies on paper tie in with Bersani’s.
Some believe the next step could be an uneasy compromise between Bersani and Berlusconi’s parties to form a loose grand coalition in order to avoid another election and stall Grillo’s rampage. But this is also the most problematic given the incompatibility between their policies.
The uncertainty has prompted a fresh bout of apprehension in European bond markets with peripheral spreads widening on the inconclusive result. No doubt as the haggling between the political parties dominates it is likely to mean discontent stock markets and lead to higher Italian bond yields.
Looking at the backdrop, the fiscal situation being left by Monti is not as severe as that of 2011 when the eurozone first blew up. However, I believe whatever the new Italian government looks like its priority should be on reviving growth because if it cannot deliver on its austerity reforms it will not be eligible for the ECB Outright Monetary Transaction (OMT) programme according to the current rules.
Measures including the OMT and the Fiscal Compact should cap the immediate downside for Italian bond spreads, but this uncertainty may cause yields to rise above Spanish yields in the short term and the ECB may have to consider resuming its Securities Market Programme to ensure depth and liquidity in those dysfunctional markets.
In the meantime, this week’s events need to be a wake-up call for Italian voters and politicians which, when taken into account after the dust has settled, should could result in an improved electoral system and a government with a clear reform mandate. One would hope the knock-on effects of this will be be good for both the country and the European capital markets.
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