Italy’s Political Fallout

After the election that took place on Monday, Italy finds itself in political gridlock. The center-left, led by Pier Luigi Bersani, hold a majority in the lower house while the center-right coalition, led by Silvio Berlusconi, won enough seats in the Senate (117) to deprive the center-left of the majority it needed to govern. Beppe Grillo, a former satirist turned populist-politician, received 25.5% of the popular vote and won 54 seats in the Senate in what is perhaps the clearest demonstration of the dissatisfaction by the Italian people with the electoral system. Mario Monti, the outgoing technocrat that led the government after Berlusconi resigned in the midst of a crisis in 2011, received a lowly 10.5% of the votes for the lower house and 9.1% for the Senate, corroborating the displeasure that the public has for the austerity measures and tax hikes enacted under his government that managed to quell some of the fear ever-present in the marketplace.

SX5E - Euro Stoxx 50 Index (5-day performance)

The effects of such a result were clearly observable in the markets. In the immediate aftermath, the Euro Stoxx 50 Index, a Blue-chip Index containing 50 “Supersector leaders” from 12 European markets, fell sharply after initial projections had the center-left with a majority in both chambers were proven wrong. The FTSE 100 in London closed 1.3% lower and the MIB stock Index in Milan closed 4.9% lower. Even more worryingly, Italian 10-year bond yields rose by about half a percentage point to 4.86%, 62 basis points below the premium commanded by Spanish debt – their narrowest margin in 4 months. Unsurprisingly, the spread on 5-year Italian credit default swaps, or the cost of insuring Italian government debt, rose to 290 basis points from 245 basis points a day earlier. According to Market Watch, this means that it now costs $290,000 annually to insure $10 million of Italian debt against default for five years, versus $245,000 on Monday[1]. The euro fell to $1.3018, its lowest level since January 7.

So what does this mean for the Eurozone? After all, more than 50% of voters cast their ballots unambiguously against the Euro, against further austerity measures, and in favor of increased spending and lower taxes. In the now likely scenario that Bersani finds himself unable to form a coalition that communicates the clear message that Italy is committed to the austerity measures and the euro, then the uncertainty and anxiety that plagued Europe for the most part of 2011 might return. If Italy’s borrowing costs start to rise, a weak government could prevent it from reaping the benefits of a European Central Bank government bond-buying program, which could prove disastrous for the region. With this scenario in mind, European leaders have already started to pile pressure on Italy’s rival parties to form a stable government.

Let’s hope that they do.

-- Andrés Muñoz

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[1] William L. Watts, "Investors Now Fear a Default by Italy more than Spain", Market Watch, http://blogs.marketwatch.com/thetell/2013/02/26/investors-now-fear-a-default-by-italy-more-than-spain/