The prospect of an anti-establishment M5S-Lega coalition government in Italy has rattled markets, with the euro testing a fresh low for this year and Italy’s 10-year spread with German Bunds widening to a four-month high of 151bps. A since-disavowed leak of a draft coalition agreement mooted radical policies such as wiping out EUR 250bn of government debt and costly fiscal programs such as a basic minimum income.
But we see several reasons the Italian outcome won’t undermine the Eurozone economic expansion or the euro itself:
- While a Lega-M5S coalition looks likelier, it is not yet a done deal. The M5S leader on Wednesday noted the need to “resolve some issues,” and both parties have promised to put a deal to a party members’ vote. Italy's President, who wields considerable power, has made it clear he would only approve pro-EU and pro-NATO ministers, and the potential coalition would be limited by a very thin majority in the Senate.
- The two parties have since released updated plans, omitting any anti-euro elements. Proposed fiscal measures, including tax cuts, unemployment subsidies and pension reform revision, would be partly funded by recovering unpaid taxes and through cost savings.
- Populist parties often become less radical after assuming power. Greece may offer an instructive parallel, where the once anti-establishment Syriza party has moved to the center, becoming both more pragmatic and less anti-euro. The M5S movement has already moderated from its anti-euro roots.
So while we must not get complacent about political risk in Italy, significant barriers to anti-euro proposals becoming government policy remain. We will continue to assess the situation as it unfolds, but we do not see significant obstacles for European growth or the euro.
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