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La Dolce Vita?

May 2018

Markets have been soothed by Italy’s apparently successful bond auction. Are they too quick to revert to business as usual?

  • The populist problem in Italy is unlikely to go away in a hurry
  • There remains a considerable gap between what the parties are saying to the European Union and what they are promising Italian citizens
  • The Eurozone may be able to ‘lose’ Italy, but not without some considerable disruption

The latest auction for five and 10-year debt was over-subscribed, with large flows rolling-over from the maturing of a previous bond. However, given that the populists haven’t even started to implement their agenda, should investors really be reassured?

The uneasy coalition between La Lega and the Five Star Alliance may be teetering and another election imminent, but it is unlikely that the populist problem is going to go away in a hurry. Polls suggest that the populists, particularly La Lega, would strengthen their lead were there to be another election tomorrow. La Lega is the more Eurosceptic of the two parties. 

There remains a considerable gap between what the parties are saying to the European Union and what they are promising Italian citizens. Their spending promises would blow EU fiscal restraints out of the water and create significant tension with their EU paymasters. At the same time, they continue to issue reassuring noises to the EU, saying that they will respect its fiscal restrictions. Something has to give.

While it is commonplace to suggest that the EU could cheerfully cut Italy with little threat of the project imploding, that view rather neglects the huge disruption and uncertainty in between. As Oscar Wilde might have said to lose one major European power may be regarded as a misfortune, to lose two, starts to look like carelessness. At the same time, let’s not forget the problems Greece created, a far more minor player on the European stage. 

Yes, financial markets have seen a little volatility, but the relative ease with which they have absorbed these problems seems blasé to say the least. Italian and Spanish spreads have widened over government bonds a little, equity markets have seen some disruption, but markets have been quick to revert to business as usual.

It may be resolved. The populists’ spending promises may prove to be the usual electioneering and hype and the constraints of government may rein them in. Citizens will vent their disillusionment at the ballot box once again. However, it is difficult to see how it can be resolved without a whole world of turmoil in between. With economic recovery waning, there may be difficulties ahead for Eurozone financial markets. 

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