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Italian Markets Buoyed Following Political Crisis

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After the collapse of Italy’s Five Star / League coalition, market expectations were bleak.  Not only had the coalition broken apart, but the eurozone’s fourth biggest economy was lurching towards quitting the eurozone. With further uncertainty ahead, both the euro and Italian bonds have been in for a rough ride at the end of May. However, despite a devastating start to last week, recent reports following Thursday’s news of a reformed coalition suggest the markets have recovered somewhat. FXTM staff writer Natasha Keary takes a closer look at the crises which engulfed Italian politics and judges its effect on the rest of Europe.

Italy’s politics have been in turmoil since March. The general election failed to find a political group who could muster a majority, and populist parties the Five Star Movement (M5S) and The League attempted to form a coalition. Under appointed leader Giuseppe Conte, the Five Star-League coalition planned to introduce expensive policies based on their shared values. These included the deportation of 500,000 migrants, a basic income for the poor and two “flat tax” rates of 15% and 20%.

The potential cost of enacting these policies (over €60 billion) left economists reeling. However, it was Conte’s choice of finance minister which abruptly ended the fragile coalition. Conte attempted to install Paolo Savona, a notorious Eurosceptic who campaigned hard for Italy’s exit from the EU. President Sergio Mattarella believed this appointment would strike a death blow for investor confidence and stepped in to veto it. Outraged (and probably a little relieved), Giuseppe Conte resigned and the first attempt at a coalition collapsed like an undercooked soufflé.

Mattarella appointed Carlo Cottarelli as interim prime minister. However, Cottarelli’s government faced a parliament in which M5S and The League hold majority. A vote of no confidence seemed extremely likely, in which case, snap elections were expected to be scheduled as early as July.

A snap election was certainly not in Mattarella’s, or the euro’s, best interests. The anger stirred up by the president’s interference fueled the flames of anti-establishment sentiment: a poll released on Monday showed a five per cent increase in vote share for the far-right League since the March election. With the support for populist parties gaining momentum, it was feared that M5S or The League could conjure an outright majority in a second election. If this were the case, Italy’s chances of remaining in the EU would be as good as dead.

Mattarella attempted to curb the possibility of a snap election by giving the parties more time to reform their coalition – and it worked. On Thursday, the Five Star / League government was reborn, and, this time, it was approved by Mattarella. Giuseppe Conte was reappointed as leader, and pro-euro Giovanna Tria replaced Savona as finance minister. The markets rejoiced at the news.

Following the collapse of the coalition at the beginning of last week, a swift fall in investor confidence left the markets trembling. Across Europe, the FTSE was down 1.37, France’s Cac 1.3, Germany’s Dax 1.85, and Spain’s Ibex 2.3. The FTSE MIB lost all its previous gains, closing down 2.7 per cent. Overall, investors were quick to sell off their Italian assets, resulting in short term bonds experiencing losses unseen for 26 years. The euro fell to a yearly low, and yields on Italian debt climbed substantially.

On Wednesday, Italy’s fortunes began to change. The markets reacted to Mattarella’s decision to give the coalition more time, and the euro soared 1.1 per cent from its yearly low the previous day. The FTSE MIB equities barometer was up 1.8 per cent, climbing back from its 2.7 per cent loss on Tuesday. Despite UBS issuing a warning over Italian bonds, an auction of €5.6 billion in Italian government debt attracted many brave investors.

Following the news of a firm coalition, this recovery continued. As of Thursday, Italian bonds rose a further 2.8 per cent, and the euro continued to climb, rising $1.17.

The latest market optimism may not last, as the Five Star / League coalition rails against the EU’s rules and regulations. The latest Eurozone May CPI data will certainly inform the way the European Central Bank reacts to developments. As FXTM’s Chief Market Strategist Hussein Sayed observes, “a better-than-expected reading will support proposals for ending quantitative easing and beginning the normalization process”.

The ECB and investors around the world are waiting with bated breath to see what happens next.

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