Fundamental Update: Italian elections – a referendum on Europe

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By Kathleen Brooks | February 23, 2013 4:31 AM EST

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On Sunday 24th February and Monday 25th February Italy will hold its first general election since 2008. The results should be known after 1400 GMT on the 25th when polling stations shut and exit polls should be released. Italy does not allow polling in the week leading up to the election, which makes the outcome uncertain. There is an unusual amount of uncertainty in this election, only a few months ago few people would have thought that former PM Silvio Berlusconi would be trying to win back power, neither did many people many people think a former comedian would generate a huge amount of excitement and become a credible force in Italian politics. But when it comes to Italy and politics, take nothing at face value.

The candidates:


There are seven candidates/ parties trying to win power including Berlusconi, the centre left Bersani, former technocratic PM Monti, comedian Grillo, Maroni from the right, Vendola of the left and Ingoria from the Civil Resolution Party.

The candidates to watch: Berlusconi, Grillo and Maroni are anti-austerity and have challenged European dominance over Italian economic policy. Grillo seems more hard-core on this than Berlusconi, his Five Star Movement has campaigned on a pledge that austerity must end in favour of a referendum on Eurozone membership and debt restructuring. These are fairly radical ideas, combined with his surge in popularity, at a recent rally in Milan 100,000 were said to have attended, make Grillo the wildcard in this election.

Latest polling data:


The last polls before the election on 8th February put centre left Bersani in the lead with 35.2% of the vote, Berlusconi in second with 28.3%, Grillo third with 15.9% of the vote and Monti in fourth with 14.8%. Grillo may have seen his share of the vote increase in the last few days; the question is will voters have moved away from Bersani, Monti or Berlusconi in favour of Grillo?

As we move closer to the election there is a chance of a hung parliament, with Bersani not able to win enough support to take control of the Senate. This leaves the prospect of either 1, a new round of elections or 2, a messy coalition that could break down. Back in 2008 Berlusconi was able to win back power because the government of Romani Prodi collapsed after an unsuccessful Senate vote to change the electoral law.

What the market thinks:


Bersani believes that Italy should stick to its fiscal treaty and European commitments, but that the focus should shift from austerity to growth. He has proposed that Italy could relinquish some budget sovereignty in favour of flexibility in terms of public investment. This makes him the most market friendly candidate together in a coalition with Monti.  If Bersani does become PM he is likely to come up against a lot of opposition from Germany over austerity, however, we believe this opposition would not threaten Italy's position in the currency bloc.

If Berlusconi becomes PM again or if Grillo becomes a force in Italian politics then we could see the prospect of a breakup of the Eurozone come back into focus. Both men don't want to toe the European (or German) line on austerity and are willing to let the people decide on their future membership of the euro. When Greece tried to do this last year, German Chancellor Merkel was willing to cut Greece loose. This caused huge amounts of volatility in financial markets and peripheral bond markets in particular, and EURUSD fell close to 1.20. Italy is the third largest economy in the currency bloc; it is not clear if the Euro project could exist without it. Thus, the hidden threat in this election is the potential break-up risk of the currency bloc. This is not a laughing matter, Mr Grillo...

The market impact:


The euro: The euro has been in decline ever since the last ECB meeting touted the prospect of a rate cut. It closed the European session on Friday below some key support levels, opening the way for further downside to 1.3120 - the 100-day sma, and then 1.2995. However, if the Italian election causes financial market stress the decline could be sharp and quick. We believe that Italian bond yields have miss-priced the risks of the Italian elections. The 10-year yield is currently below 4.5%. An adverse outcome could see bond yields spike in Italy, and potentially Spain as investors fear that anti-Europe/ anti-austerity fever could spread. The euro has a fairly strong inverse correlation with peripheral bond yields, so as yields rise the euro tends to drop. Any stress caused by the elections could see us sub- 1.30 and back towards 1.25 in EURUSD very quickly. This would also affect EURJPY. In the event of a problematic election result, EURJPY drop back to 119.30 - the 50-day sma and a key support zone - in the short term.

Stocks: Italy's FTSE MIB index has fallen nearly 10% since the start of this month, as election risk has been concentrated in the domestic stock market. In fairness the stock market has had to deal with a double whammy - a plethora of economic data misses - along with the election risks. Thus, we could see further downside in Italian stocks as we don't think the growth outlook will pick up any time soon. The European Commission expects Italy's GDP to contract by 1% this year and for unemployment to rise to 11.6%.

Overall, a hung parliament that leads to a re-run of elections may be the worst outcome for global risk assets, particularly European assets, as fears rise that the currency bloc could break up, yet again. This election is a keen reminder that the problems in the currency bloc are far from over, and talk of stabilisation in recent months was a delusion.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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