Italian Election: Trauma In Roma

Italy’s general election has produced a deadlock, with the centre-left Democratic Party (PD)-led alliance winning control of the Chamber of Deputies (lower house), but failing to win a majority in the Senate, where the centre-right People of Freedom (PdL)-led alliance of ex-PM Silvio Berlusconi has the edge, but is far from a majority. (Italian governments need the backing of both houses to rule the country.) The big winner was the new 5-Star Movement (M5S) of internet activist and ex-comedian Beppe Grillo. The big loser was outgoing premier Mario Monti’s Civic Choice bloc. Overall, around 55% of Italians backed parties opposed to what many see as Germany-imposed austerity measures.

This deadlock is the last thing that eurozone policymakers and investors want to see. Monti’s technocratic administration, in place since November 2011, has won plaudits from financial market players for implementing fiscal reforms, but Italians are clearly fed up of these measures, which they see as prolonging the country’s recession. From a market point of view, a weak government will mean a waning commitment to tackling Italy’s debt woes. This explains why Italy’s 10-year bond yield jumped 45 basis points to a 2½ -month high of 4.94% at one stage on February 26.

Italy – 10-Year Bond Yield (%)

Attention To Focus On Coalition Building In The Near Term

Parliament will convene on March 15. Over the coming days and weeks, we expect the PD to attempt to form a viable coalition so that it can gain the Senate majority needed to govern. However, this will not be easy, and it is unclear who it could join hands with. At present, a grand coalition between Bersani’s PD and Berlusconi’s PdL would appear to be unlikely, given that the parties are bitterly opposed to each other, and a pact between them would probably not last long. Moreover, the bigger the coalition, the more unwieldy it would be, and the higher the risk of extended gridlock. The PD could also attempt to attract the support of M5S, but the movement is reluctant to join forces with a traditional party for fear of compromising its anti-establishment credentials. Yet if M5S chooses to remain completely separate from governance, it would risk losing relevance over the longer term. Thus, M5S also faces a dilemma on how to build on its success.

New Election Likely

Given this backdrop, we believe that Italy may need to hold another general election before the end of 2013 to produce a more decisive result. However, this may necessitate changing the electoral law, which could take time. In the meantime, President Giorgio Napolitano could install an interim government. Therefore, Italy could face months of political uncertainty, which could cause bond yields to rise further and bring concerns about the eurozone’s survival back to the top of the agenda. Finally, even if Italy holds a fresh election, there is no guarantee that this would result in a more durable or market-friendly government.