Italy`s economy has accelerated over the course of 2017, despite the lingering uncertainty about the 2018 general election. The threat of anti-EU, populist forces coming to power has receded following the reform of the electoral law.
However, rising political fragmentation will create difficult coalition dynamics. In our view, the most probable political outcome is a multi-party coalition government headed by the center-right that stretches across the political divide. Rather than a tectonic shift, the 2018 election looks set to deliver ‘more of the same’ with Italian politics having long been characterized by uncertainty and instability.
Such an outcome will hence trigger only a limited spread widening for Italian government bonds and will have little direct impact on the economy. The negative impact of elevated financial market stress on public finances should be limited. The duration of Italy`s government debt is rather long, so that refinancing needs are limited in the short term. Also, present borrowing rates for Italy are still significantly lower than the average rate on all outstanding bonds (around 3 %).
So the downside is limited. On the other hand, it seems unlikely that the election outcome will herald bolder reform moves for higher growth. Thus there is limited upside as well.