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John Chatfeild-Roberts: What does Italy’s election mean for the rest of the eurozone?

Italy’s recent election can be important for goings on in the rest of the eurozone

The Italian electorate, clearly dissatisfied with the EU and its incumbent political class, has plunged the country into constitutional crisis.

Two months beyond the inconclusive March general election, Italian political parties had been struggling to stitch together a workable coalition which might produce some semblance of a stable, effective government.

The two parties with the biggest share of the vote, Five Star (a left-wing anti-establishment party) and The League (a right-wing, on-off secessionist party from the north), seemed unlikely bedfellows. The only common ground between the two, apart from neither party having ever been in government, is a visceral loathing of the euro and Brussels’ centralisation.

When, in late March, these two announced the proposal of a coalition and a radical economic package – including €250bn of debt relief from the EU, abandoning pension reform and rowing back on austerity economics with a significant spending plan – it was as if a political nuclear device had detonated in Europe.

Brussels, its antennae as blunt as ever, reacted predictably and the Italian president vetoed the appointment of a dyed-in-the-wool left-wing eurosceptic academic as finance minister. As the situation threatened to unravel quickly, further negotiations did secure the president’s approval for prime minister Giuseppe Conte and his ministers. So the politically-inexperienced new government is currently in the process of setting out its stall; whether it eventually succeeds, survives or disintegrates remains an open question.

Fixed income volatility

Italy is the third-largest economy in the eurozone, and only ranks behind Germany for manufacturing, so what happens in Italy matters a great deal. Financial markets’ initial reaction to the crisis was swift, as investors rapidly dumped Italian government bonds and the bonds of Italian companies potentially vulnerable to financial dislocation (especially banks, which in Italy are notoriously wobbly even at the best of times).

Italy’s politically-inexperienced new government is currently in the process of setting out its stall

Investors also sold bonds of other potentially risky eurozone governments, notably Greece, Spain and Portugal, and instead switched to perceived safe-haven German and US bonds. As a result, bond-price volatility was at its greatest since before the global financial crisis and bond markets are likely to remain volatile until the fog lifts. Equity markets reacted too, although less dramatically than the bond market.

In the near-term, we believe these events are unlikely to undermine global economic growth, though much will depend on how central banks react, especially the European Central Bank. It would certainly be significant if Italy were to eventually leave the euro, and it would pose a systemic economic and financial threat if the euro were to collapse as a result. At present, that does not seem a likely outcome, but stranger things have happened.

Further afield

Consistently through the pre-election hustings in 2016, Donald Trump was emphatic: he thought the Iranian nuclear containment treaty, negotiated on his predecessor’s watch, was “a terrible deal” and, when in office, he would have no hesitation withdrawing the US from it. He has since done precisely that in the face of strong opposition from co-signatories to the treaty, notably Nato allies, but also Russia and China. At the same time, he announced the resumption of punitive sanctions on Iran, including an effective embargo on oil exports.

Oil traders responded to the embargo and the price of oil spiked, briefly reaching $80 per barrel, a price not seen since it was going the other way in the 2014 collapse. These are big gyrations in the price of the world’s most important commodity. Happily, compared with a generation ago, the march of technological and economic progress has made the global economy less vulnerable to significant spikes in the price of oil, both in terms of inflation and economic activity. Politically, however, an already unstable Middle East situation has become more febrile; an upcoming OPEC meeting could be a catalyst, as Saudi Arabia (Iran’s implacable foe) and Russia (Iran’s ally in the Syrian war) are each likely to take advantage of Iran’s plight to increase their own oil production.

John Chatfeild-Roberts is head of strategy for the Jupiter Independent Funds Team

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