Italy: Navigating political uncertainty

5 min
Ana Boata
Ana Boata Senior Economist for Europe

In the wake of renewed political blockage, market reaction has been subsequent: the surge in the 10-year spread has been one of the fastest in history and the sovereign yield curve has flattened for the first time since 2007. While asymmetric, there was a reaction in the CDS of Italian banks as markets turned their attention on possible liquidity tensions. Fresh elections are now likely to be organized as early as July and as latest as early 2019. While it is difficult to predict what could come next, we envisage several scenarios. The most probable one (our baseline) sees a governing coalition that will implement moderate fiscal expansion while markedly toning down Eurosceptic rhetoric amid elevated market tensions. We continue to expect the ECB to prolong its QE program until December 2018 at least and to delay its first rate hikes until late 2019. Moderate fiscal expansion will drive fiscal deficit slightly above -3% of GDP in 2019 and primary surplus down to around +0.5% of GDP. Liquidity tensions for banks would remain limited as well as contagion to the peripheral Eurozone countries. Italian annual GDP growth would be below +1% on average in 2019-20.