2019: Italian bluster

We said:

Italy’s leaked draft coalition agreement has alarmed investors. At the end of last week, we wrote that investors shouldn’t be overly worried by the prospect of a new, populist M5S-Lega coalition governing Italy. Then Tuesday’s leak of a draft coalition agreement put a cat among the pigeons. 

Demanding a return to a pre-Maastricht Europe, a mechanism to leave the euro and that €250bn of debt be written off by the ECB was always going to ruffle feathers. But welcoming market turbulence as a sign that the coalition was on the right track – as did Lega leader Matteo Salvini – can’t have done much to help, either. The BTP-Bund spread has now risen to 153bp, its widest since January, after hitting a low of 112bp in April; and the FTSE MIB fell sharply, led by the banks.

Despite all this, we see no reason to change our core view – which is that the risks to Italy in the near to medium term are of bad and profligate government, not redenomination. In the circumstances however, it would be reasonable to worry that the original leak reveals a Eurosceptic agenda far more radical than seemed recently to be the case. Here are some reasons to be reassured:

The leak tells us nothing new about either party’s position on the euro. Neither is going to seriously threaten withdrawal while the economy is finally seeing some growth. And now both now insist that their coalition agreement will not question in any way Italy’s membership of the single currency.

A more realistic worry is bad and profligate government. None of this is to say that we are entirely sanguine about the new government. We’ve long warned that the real risk from the Italian elections was wasteful spending, poor government and in the worst case scenario the flouting of European law, and on these fronts the final draft of the coalition agreement is not very reassuring.

A lot of noise will come out of Italy in the next few months, and we do not deny that there are real risks stemming from the new government. But this week’s leaks are all bluster. 

Outcome:

The coalition government quickly moved to a less aggressive policy stance. As we predicted the main concern for investors became the Italian budget deficit and the new government's attempts to agree a wider deficit with the EU.