The following article was written by Jasper Lawler, Senior Market Analyst at FCA regulated broker LCG.
Jasper Lawler
Political turmoil in Italy has seen investors sell out of Italian stocks at an unpredicted rate. The FTSE Mib plummeted over 9% in May and has continued to sell off in June, plunging from a 10 year high of 24,544 a month ago, to 21,122 last week, its lowest level since last summer. Interest in Italian stocks did pick up slightly following the creation of the coalition government, however the relief rally was short lived, and the selloff has since continued.
It has not just been Italian stocks which have been impacted by the political developments in Italy, Italian bonds have tumbled whilst stocks across Europe were also been dragged down by the increased political uncertainty in Italy. Although notably, European bourses have maintained Friday’s relief rally gains.
The euro was another victim of Italian political concerns, falling over 3.5% across May, from a high of just shy of $1.20 to a low last Thursday of $1.1511. However, the euro has also managed to maintain its recovery, currently pushing back towards $1.1750.
Whilst the sheer thought of two populist Eurosceptic parties taking the reins in Italy sent a shiver down the spine of euro traders, the common currency appears to have found an ally in Prime Minister Giuseppe Conte, who confirmed that this government in not intending to remove Italy from the eurozone. That simple confirmation, in addition to talk of ending QE at the ECB has been sufficient to boost the euro well on its way to clawing back last month’s losses.
Populist policies will grow Italy’s already large debt burden
The new Italian Prime Minister Giuseppe Conte passed his first parliamentary hurdle by winning a both confidence votes. Yet far from showing signs of relief, investors of Italian stocks and bonds are still showing signs of caution after Giuseppe Conte alarmed investors with his maiden speech.
Vows to enact a broad range of populist measures, such a boosting spending on the poor and unemployed with a “citizens income”, whilst pledging sweeping tax cuts will only add to Italy’s heavy debt burden. The programme of fiscal expansion showed that there are no plans to water down the populist policies and that in itself is frightening investors, sending Italian stocks and bonds significantly lower, whilst yields peaked at around 3.1% up from 2.4% in just 4 days.
The ambitious anti-austerity measures are likely to be met with a stern eye from rating agencies. Rating agencies have already threatened to cut Italy’s debt ratings as the new government will weaken public finances. Given that Italy holds the world’s third largest public debt at around €2 trillion, an increase in spending and the undoing of earlier reforms is understandably unnerving investors. All of which it worryingly reminiscent of the recent sovereign debt crisis.
Outlook for Italian markets & Euro
Investors will be watching closely across the summer months to see how much the government actually achieves. It took these two parties three months to form a coalition so that tells us that they are not sat on the same page for a lot of policies and principles. If they manage to achieve even just half of what they are looking to do, then come the Autumn we could see some serious implications in the markets. Whilst the Italian economy is stronger than Greece’s was around the sovereign debt crisis, huge debt with lacklustre growth is a recipe for disaster.
Demand for Italian stocks is expected to remain weak until there is further clarity over how these two parties work together. Italian debt is expected to remain out of favour for the simple fear of Italian debt swelling. On the positive side, the worst-case scenario of Italy leaving the Eurozone appears to be off the table, meaning euro traders will shift their focus elsewhere for now.