We are out of a long political crisis. It’s premature to discuss what measures will be taken by the new government and how that will affect partners, but it is a clear fact that Italy is in Europe and will stay in Europe.
That’s from Bank of Italy Governor Ignazio Visco, who spoke to Bloomberg TV while commiserating with his compatriots on the sidelines of G-7 meeting in Canada.
While it’s nice that Ignazio is prepared to offer some ostensibly reassuring words, I employ the term “ostensibly” there for a reason. There’s not much that could be fairly characterized as “a clear fact” on the Italian political scene right now, with perhaps the exception of the “fact” that the country now has a populist government and that fact, in turn, makes it quite difficult to couch anything else in definitive terms.
Consider these excerpts from a Reuters piece out on Saturday:
Government officials will have planned the move in the utmost secrecy, telling their European partners only that same evening while simultaneously ordering the shutdown of banks and financial markets to prevent a stampede of capital out of the country.
This is “Italy’s Plan B”, an eye-popping contingency scenario drawn up by the team at a website specializing in economic issues, for how the euro zone’s third-largest economy should go about returning to the lira if necessary.
The 80-page pamphlet was overlooked when it first appeared in October 2015, and would ordinarily have stayed that way.
But then one of the best-known contributors to the website, 81-year-old economist Paolo Savona, was put forward last week as a candidate for economy minister under the new anti-establishment coalition between the right-wing League and the 5-Star Movement.
The government forged on Thursday has since relegated Savona to the more junior European affairs portfolio after the head of state refused to allow an arch euroskeptic to occupy the key economics ministry.
And inside the League, which is dominant in the wealthy Lombardy and Veneto regions in the north, sources say there are no signs of anxiety that leader Matteo Salvini would ever risk the chaos of pulling the country out of the single currency.
Nevertheless, “Plan B” remains on the list of compulsory reading for those seeking to understand the intellectual foundations of the new coalition.
Again, that’s from a much longer piece that you’re encouraged to read in full, but you get the point. This is far from “resolved”, although you wouldn’t know it to look at Italian assets, which rebounded to close the week.
For those who missed it, here’s the retrace in BTPs:
And all things considered, the losses for Italian equities were modest, although this was the fourth weekly decline in a row:
Whether that represents folks attempting to hold their nose and buy on the assumption that the fire sale that characterized Tuesday’s frantic session was overdone or investors actually believing that somehow this situation will work out over the long-term is debatable, but as Deutsche Bank’s Aleksandar Kocic notes in his latest piece, “it is difficult to see a clear path towards resolution of this problem given the current political configuration.”
Here’s Kocic putting things in perspective in terms of the extent to which a shared disdain for globalization and a desire to capitalize on disaffection among certain swaths of the electorate has transcended traditional political divides:
Last week’s developments in Italy and their reverberations across all market sectors constituted another reminder of the changing topology of the political landscape. The unlikely coalition of the two populist wings on opposite sides of political spectrum shows that traditional political antagonisms have been transposed into non-traditional alliances driven by mutual opposition to the forces of globalization. Although not conventional, the underlying bond does carry a certain logic, indicating that the antagonisms toward the global have grown so strong that they transcend the traditional differences between the two opposing ideas of social organization.
That’s obviously an important observation and represents a somewhat disconcerting development. Kocic goes on to explain why something will ultimately have to give:
Fiscal improvements in Italy since 2011 have been financed largely by austerity measures. These measures were at the root of the populist victory this year. However, the nonlinearity of the problem reflects the incompatibility of the socio- political demands represented by the coalition parties with economic and fiscal realities: While maintenance of the current good fiscal standing does not look politically sustainable, the proposed fiscal spending would improve wages at the price of eroding the fiscal situation and, as such, become incompatible with the EMU.
Given that, the obvious question (and if you want to know just how important of a question this really is, just ask Bill Gross) is whether the ECB will ultimately be forced to relent when it comes to ending APP in September.
This calculus is complicated immeasurably by the deceleration in the eurozone economy in Q1. Paradoxically, a continuation of Q1’s deceleration might be just what the doctored ordered if you’re long European risk (i.e., equities or credit) although if you’re a euro bull, clearly that’s about the last thing you want. For those interested in the longer discussion on that, see “I Don’t Know You Guys, It Seems Like That German Inflation Print Is Bad News When It Comes To Whether The ECB Will Be Inclined To Rescue Italy.”
For what it’s worth, here’s a pretty balanced take on this from BNP that, while not exactly the most riveting analysis in the world, is worth a skim for anyone interested in keeping track of the all the variables in the ECB’s decision calculus:
Here of course the Italian situation has to be put in the context of the outlook for the eurozone as a whole and this looks like a mixed bag. As we discussed in more detail in our global outlook report, the slowdown in eurozone activity in Q1 was due to a mix of temporary and more enduring factors. The latter includes increasing supply constraints, however. In addition, April hard data, in particular in Germany, support the view of a rebound in activity after the sharp slowdown early in the year. Also, we continue to believe that inflationary pressure will gradually emerge. At the same time, recent events, including the intensification of the trade war and the Italian political impasse, mean that compared to our central case of continued above-potential growth, the risks are skewed to the downside. Combine everything together, and we see plenty of reasons for the ECB to remain cautious and use very dovish language, especially with reference to interest rate hikes. But we see fewer reasons for it to change course completely and postpone the end of QE beyond December this year — not least because such a choice could be erroneously thought of as giving Italy a helping hand and be portrayed as a political decision. So, barring a more significant and generalised deterioration in activity, we continue to think the ECB will taper net asset purchases in Q4, with a view to ending them in December. The language accompanying the adjustment, however, is likely to remain dovish to keep expectations of incoming rate hikes under control.
