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Special Report: The Italian General Election

Posted on: 28 February 2018 , by: Darren Sinden , category: Market Review

Special Report: The Italian General Election

What Traders Need to Know

On Sunday the 4th of March, the Italian General Election will take place in what is essentially a three-way contest that is too close to call. Regardless of the outcome, the election will be a major test for the European Union, potentially tipping the eurozone back into crisis. Get all the key information from Market Analyst Darren Sinden, including what the outcomes could mean for the Euro.

The Italian Political System - A Flawed Democracy?

Italian voters head to the polls once more on Sunday, a process that the electorate is used to, having had more than 60 administrations since the end of WWII.

The complexity of the Italian political system has been described as a flawed democracy by the Economists respected intelligence unit. Regional divides and wide-ranging political views among voters have combined to create what, to outsiders, looks like a chaotic system. In an ideal world, Sunday's election will identify a new leader and ruling party to take Italy forward after several years of political malaise. Unfortunately, this is not an ideal world, and we are unlikely to see anything quite so clear cut from the results. 

The Coalitions to Watch

Forza Italia

Former Prime minister Silvio Berlusconi and his right-wing Forza Italia party. Berlusconi is probably Italy's best-known politician of modern times; he has had a chequered and controversial career in both politics and business, which culminated in a conviction for tax fraud in 2013 although he served no jail time. Berlusconi's conviction will prevent him from serving in elected office for another six years, yet he is able to retain the leadership of Forza Italia which has been forecast to win around 18% of the votes on Sunday. This means that Signor Berlusconi could have a significant role to play in the election outcome even from afar. Berlusconi's party has a coalition agreement with the Lega Nord or Northern league. A party on the far right of politics in Italy with a separatist, anti-immigration anti-EU and anti-crime agenda they are forecast to garner another 13% of Sunday's votes.

Five Star Movement

On the other side of the political divide is the FiveStar Movement founded in 2009 by comedian Beppe Grillo and Milan-based entrepreneur Gianroberto Casaleggio (who died in 2016). Five Star describes itself as a movement rather than a party and has a broad-based appeal and wide-ranging policies. That can be thought of as populist and anti-establishment at the same time. The movement was formed out of frustration with the status quo in Italy. This approach has proved popular amongst voters, and Five Star won the most votes of any party in the country’s 2013 election. But it failed to turn that showing into seats at the top table because of its outright refusal to form a coalition. This time round, Five Star is forecast to win 28% of the vote. 

Democratic Party

Recently ousted Prime minister Matteo Renzi and his Democratic Party, of which current PM Paolo Gentiloni is a member (see below), is thought likely to win some 23% of Sunday's polling and may be able to leverage that showing through an alliance with several smaller centre-left groupings. But make no mistake Berlusconi and his Lega Nord allies will be trying to stitch together a similar arrangement with the minor right-wing parties. 

Recent polling suggests that this combination of the right could win 295 out of 630 lower house seats up for grabs, potentially making them the biggest group in the new parliament but not large enough for an outright victory. In these circumstances, Forza Italia and its allies will get the "first crack" at forming a ruling coalition. However, it's unlikely that any party of the centre-left or left wing will want to share power with people to whom they are ideologically opposed. 
Beppe Grillo's stance on coalitions is unlikely to have changed from 2013. So unless Five Star wins outright or Matteo Renzi can talk Mr Grillo round, a hung parliament is the most likely result, effectively leaving Italy back at square one. 

The current Prime Minister Paolo Gentiloni who came to power in October after his predecessor, Matteo Renzi, lost a referendum on constitutional reform, is not expected to feature prominently. Gentiloni is seen as a caretaker figure and is highly unlikely to retain power after Sunday's poll. 

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Not What the Country Needs 

Continued political stalemate is the last thing that the Italian economy needs. True, it is still Europe's fourth-largest economy, but it faces significant challenges and has failed to recover from the events of a decade ago. The chart below shows the gulf between GDP per capita, or head of population in Italy, compared to that of Germany, over the last decade. 

 Gulf between GDP per capita compared to Germany,over the last decade

Unemployment in Italy, though improving, is some two and a half times that of Germany, at 10.5% and well ahead of the Eurozone average of 8.5%. Levels of national debt have risen sharply over the last ten years as well, and Italy's ratio of debt to GDP stands at 132.6%, compared to just 96% in France and 99.4% in Spain.

Potential Election Outcomes - How will Markets React?

Voting booths open at 7.00 am on Sunday and close at 10.00 pm GMT, shortly before FX markets open for business. Exit polls are expected to be published immediately after the polls close - they have a history of accuracy in calling the winners, but a higher margin of error in transferring that data into a calculation of majorities and numbers of seats won. Changes to the electoral system which now combines elements of proportional representation and first past the post will only complicate this exercise further.

Against this background, it's hard to predict exactly how the markets will react. But we can make some broad brush observations: 

The better the showing of the right-wing parties in aggregate, led by Forza Italy, then the more nervous the markets may become. Italy is unlikely to leave the Euro, but many of the politicians on the right believe that this idea should be discussed. On top of this, the right favours a fiscal expansion of some €100 bln Euros; something that is currently prohibited under EU rules and which would bring the new administration into direct conflict with the powers that be in Brussels. That fear is likely to put downside pressure on the Euro (which recently scored a lowly 53% popularity rating among Italians). And of course, we could see volatility in early trade in Asia Pacific markets, which are not as deep or liquid ahead of the European open. 

If the centre-left should contradict polling and win the lion's share of Sunday's vote, then that could prompt a relief rally in the Euro. However, the truth is that the result will likely fall somewhere between these two extremes and that a prolonged period of negotiation will then ensue (as the various parties horse trade to form a workable coalition). 

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