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Italian Political Risk Bubbling

21 June 2016 by Mark Holman

While markets are currently ebbing and flowing with poll sentiment ahead of the UK “Brexit” vote on Thursday another political tail risk entered the market this weekend. This potential risk could be even bigger for markets down the line, but will probably be largely ignored for some time as other events continue to be market drivers.

The risk I refer to is that of Italy’s 5 Star Movement, headed up by former comedian-cum-political leader Beppe Grillo, which came close to threatening the political establishment in Italy at the last elections before Matteo Renzi became Prime Minister February 2014. At the time few would have thought that Renzi’s government would retain control for so long, but he has. However, his policies have not been universally popular within Italy. This is a trend that we have seen all across Europe as voters protest against austerity, a point we will be reminded of this Sunday as Spanish voters go to the polls for a re-run of the 2015 election that failed to result in a government.

As a reminder, Grillo is calling for anti-austerity measures and, more importantly for markets, pledging to pull Italy out of the Eurozone and the wider EU bloc. Given the enormous size of Italy’s debt burden and its status in the G7, having Grillo’s party in power would almost certainly give markets a re-run of Q3-2011 although this time it will be based on “Itexit” fears.

Renzi’s grip on power now depends on the constitutional referendum that will take place in October and will require the electorate to pass a package of institutional reforms that were at the core of the Prime Minister’s agenda, and which raised the hackles of the right opposition and the more “conservative” members of Renzi’s own party. Passing the package would be positive for Renzi and enable him to pass new legislation efficiently; but a failure to pass the package would result in Renzi standing down and thereby forcing a new election, which would be welcomed by Grillo.

So why is this risk resurfacing now? At the weekend the second round of elections for Italian local councils took place, including most major cities like Rome, Milan, Turin and Naples.  While the government managed to retain power in Milan they lost the race in the capital, with the 5 Star Movement winning 19 of the 20 councils following a resounding victory in the second round of voting. On paper this looks bad, however there are some technicalities that led to the wins for the 5 Star Movement.  In Rome, for example, the centre-right parties would have won the mayoral seat had it not been for the fact that they presented 2 candidates that split their vote. In addition, they indicated that they would support the 5 Star Movement candidate in the second round as a sign of direct animosity towards the government. Far from ideal for Renzi.

While Renzi still does have the upper hand and most likely will get his reforms through in October, we must not ignore though the popularity of the 5 Star Movement and bear in mind that it is very easy in Italy to trigger no confidence votes in Parliament and ultimately an early election ahead of the scheduled one in 2018.

This is certainly a story to follow and will keep the EU in the limelight, even if we haven’t had enough with the UK referendum and Spanish re-elections!

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