With Ancient Rome for its heritage, it’s no surprise that the politics of Italy are often dramatic and unpredictable.
The latest bout of uncertainty, however, has sent equity and bond markets into hysterics. But are investors over-reacting?
On February 9, Bank of Italy chief Ignazio Visco gave a speech to a conference in Bergamo in which he anticipated the investment world would be watching the Italian election – and its potential impact on Italian monetary policy and European financial markets – with bated breath.
“Italy must not lower its guard,” Mr Visco said. “The attention of international investors continues to focus, rightly, on our capacity to preserve balance in public finances and to pursue with determination, an increase in our development potential.”
Not only were investors paying attention but they didn’t like what they saw. As exit polls started to flow in from voting booths across the ‘boot and ball’ – many of them showing better-than-expected results for former prime minister Silvio Berlusconi’s centre-right coalition – Italian shares and bonds lost earlier gains.
The final results – with the centre-left coalition led by Pier Luigi Bersani winning a majority in the lower but not the upper house, and a strong showing for the protest party Five Star Movement – were inconclusive, potentially meaning another election will need to be scheduled.
This would offer anything and everything but certainty for global investors.
Described by Douglas J Elliott of the Brookings Institution, a US think-tank, as a “triumph for fantasy and irresponsibility”, the election results have triggered panic.
“The Italian elections have prompted a fresh bout of uncertainty in European bond markets, with peripheral spreads widening sharply on the inconclusive result,” said Standard Life Investments’ investment director, Jack Kelly.
Standard Life Investments’ head of global strategy, Andrew Milligan, chimes in that investors need to think about ‘tail risks’. “At the very least, a prolonged period of uncertainty faces the Italian economy, affecting investor sentiment,” he said.
“In coming months, fiscal slippage and obstacles to structural and labour market reforms would not at all be well received by global investors,” he added.
“The probability is low, but not negligible, that Italy will have a referendum on EU membership before this political crisis comes to an end.”
AMP Capital chief economist and head of investment strategy Shane Oliver also emphasises the potential risks posed by a dramatic shift in Italian fiscal policy and general uncertainty.
“If the reform process does not continue, not only does it raise questions about Italy’s long-term growth potential thanks to an over-regulated and uncompetitive economy, but it also raises questions as to whether it would be able to qualify for support from the European bailout fund and hence for support from the European Central Bank if a surge in its borrowing costs made that necessary,” he said.
“Hence, investors are fearful that stalled reforms and political uncertainty in Italy will lead to soaring Italian bond yields, the renewed risk of a break-up in the euro should Italy choose to leave, and a renewed threat to the global economy.”
But in a measured tone that Australian institutional investors may appreciate, Dr Oliver has also called for calm, stressing that over-reaction to the Italian political situation would be most unwise.
“Uncertainty is likely to linger for several weeks, but as we have seen in recent times in Europe there is a danger of overreacting as blow ups have tended to settle down without the feared collapse of the euro,” he said.
“Our assessment is that while the correction in share markets may have a bit further to go, not helped by Italy, the broad rising trend in markets will likely continue.”
