The Next "Eurothriller" - Italy

The next risk-event on the horizon for foreign exchange markets appears to be the possibility of a new Italian general election being held earlier than previously expected.

The election is seen as a destabilising risk to the Eurozone and the Euro because of the popularity of the maverick 5-star movement who want to see an end to the Euro and a break from the EU.

Rumours of a snap general election were sparked after former Prime Minister Matteo Renzi joined a growing bi-partisan group calling for a ‘German-style’ reform of the voting system which would, if it was successful, put pressure on President Mattarella to dissolve parliament and hold a snap election in September 2017.

"If elections are called by the end of September, there will be renewed worries about a major eurozone country exiting the EUR," says Pierre Carlsson at Hendelsbanken, the Nordic banking group.

New proposals would require that a political party would need five percent of the votes to get into parliament.

Parties such as the The Brothers of Italy (BI) and The Left Party (LP) will be in danger of missing out.

This seems to be supported by Forza Italia and, surprisingly, the M5S.

"Nevertheless, the schedule to accomplish this is very tight. First of all, there are still many details to put in
place before presenting the actual bill to parliament. This and the vote need to be established before the summer recess at the end of July," says Carlsson.

When in place, the government needs to be voted down in a no-confidence vote after which the President will dissolve the Parliament and call the election no sooner than 50 days later

Risks Contained for Now

Quite apart from the substantial parliamentary leg work required to push through the reforms necessary for an early election, the chances of a majority anti-EU government gaining power from such an election are relatively low, according to analysts at Credit Suisse.

This explains the so far relatively muted reaction to the news from financial markets.

In the currency markets the news has put a reign on the Euro’s rally higher but not snuffed it out completely.

In the bond markets the uncertainty caused a sell-off in Italian bonds.

The actual impact is most quantifiable using options pricing models, which have seen a widening in the difference between 3 and 6 month implied volatility for Euro currency options, according to Credit Suisse’s Shahab Jalinoos.

The relatively sober response from the markets, however, reflects the fact that in reality the chances of an Italexit are relatively small.

“First, while the Five Star Movement is still doing well in opinion polls, it is not seen as likely to be able to form a government – the parliamentary structure being discussed seems most likely to lead to a hung parliament,” said Jalinoos.

Appropriate anti-EU bedfellows for 5-Star to form a hung parliament with appear limited.

“The only other major party that expressly favors Italy leaving the euro area is the Northern League, which is by design a minority, regional party,” added the Credit Suisse Strategist.

The most likely outcome of a snap election would not be a coalition between 5-Star and the Northern League.

A much more likely outcome would be an arrangement between the ruling pro-Euro PD and Berlusconi's Forza Italia, and while Berlusconi has made negative comments about the Euro in the past, “our sense is that he is most likely to take a pragmatic line on this issue if public opinion polls continue to show that Italians as a whole do not wish to see Italy break with the euro,” said Credit Suisse.

Another possibility overshadowed by all the fuss over Italexit fears, is that a coalition government might be able to achieve more economic reform in Italy, which would speed up the recovery – an outcome seen as a positive not a negative risk to the Euro.

As for the actual mechanics of bringing the date of the election forward from April 2018 to September, there are still significant hoops to be jumped through which does not make this most analysts base case in the first place.

“The electoral system still has to be detailed in a draft law submitted to Parliament and voted before the summer recess (end-July) for elections to occur in the autumn,” commented Giada Giani at Citigroup.

“Once that is done, the government has to be voted down in a no-confidence vote, the President has to dissolve Parliament and call the election – a minimum of 50 and maximum of 70 days after parliament is dissolved,” she added.

So far now risks are low, but expect a market that has an obsession to politics to eventually start paying more attention.