Strong support for anti-establishment parties
At the time of writing, no party or coalition has obtained an outright majority in the Senate or in the House. The center-right (CR) coalition formed by Forza Italia (FI), Lega Nord (LN) and Fratelli d’Italia (FDI) ‘won’ the Italian election. This result was consistent with pre-election polls. However, the more radical LN surpassed FI in votes and thus would likely lead the coalition.
The single party who got the most votes was M5S, confirmed to be the first Italian party and breaking the 30% threshold both in the House and the Senate. Support for the incumbent party - the PD - and its centre-left coalition, was lower than even the polls suggested at below 20%.
The level of participation was better than expected - around 73% - which demonstrates the degree of dissatisfaction with the political status quo.
Allocation of seats is not yet available and will be announced in the coming days. Seat allocation could differ at the margin from the percentage of votes, due to the complexity of the electoral law, which adds another level of uncertainty to the potential scenarios that could emerge.
The President Sergio Mattarella will now play a pivotal role in the next steps and is able to exercise considerable discretion. He will immediately start informal consultations to identify a candidate to try to form a government. But formal agreements can start only in April. The ambition is to have seats allocated and the two houses of the new Parliament formed, so that a new government is in charge in May. If the candidate initially chosen to form a government fails, the mandate is passed to the next candidate who seems most likely to reach agreement with other parties.
The following scenarios seem most probable:
- The centre-right coalition is given first opportunity to form a government. Given the victory of LN over FI within this coalition, Matteo Salvini – the leader of LN - could get the first exploratory mandate on behalf of the CR coalition. Antonio Tajani, the leader of FI and current President of the European Parliament – could yet be given the opportunity if other parties are not willing to enter an agreement with a government headed by Salvini. A CR coalition that involves other centrist parties, like PD or +Europe, could be welcome by markets, as it would mean more attention on reforms, fiscal rigor and pro-Europe stance, but such a coalition is still hard to imagine. It will also be important to understand how LN and FI and other parties will agree a joint programme on crucial themes like immigration, fiscal and pension reform, and the relationship with European institutions.
- The M5S could soften its anti-establishment stance to form a collation but this would be a significant deviation from its pre-election stance. A populist coalition, the highest concern for markets, formed by M5S, LN and FDI (all populist parties) is numerically possible, but still appears to be a remote possibility.
- The PD could play a role in a coalition but may prefer to stick to its ideals and be the main opposition party. A grand coalition involving the FI, PD and minor centrist parties probably won’t reach enough seats to have a majority. As the most pro-reform and pro-Europe party such a lack of participation could be disappointing for markets.
- New elections will be called if consultations fail. It is also possible that parties ask to change the electoral law to a system that is more likely to produce stability and governability. An alternative electoral law could shift to a majority system or a second round of votes. This is not the ideal scenario for markets in the long term, but it could mean that Paolo Gentiloni, the leader of the ruling government, could remain in charge in the interim for the ordinary administration.
What does this mean for investors ?
This election demonstrated that the new electoral system (Rosatellum) has failed to deliver more conclusive election results. Italy now faces a potentially long period of political instability – though this is not news for a country that has been plagued with weak, fragile governments for decades.
A centre-right coalition is feasible, if common ground can be found on immigration, fiscal and pension reforms, and interaction with the European institutions. The most market unfriendly scenario – a coalition of populist parties, like LN and M5S - still seems unlikely in our view even if these parties gained more of the vote than anticipated given their reluctance to work with other parties. For this reason the extreme risk of an anti-Europe drift seems an unlikely scenario.
Italian markets have suffered at the news but other European markets have been less affected. At the time of writing Italy’s FTSE MIB was down 1%. The Italian 10Y yield spread versus the Bund rose to 1.37% but remains well below the levels seen in the sovereign crisis.
EXHIBIT 1: ITALIAN MARKET REACTION HAS BEEN RELATIVELY SUBDUED
% yield, Italy 10-year bond yield minus German 10-year bond yield
Source: Bloomberg, J.P. Morgan Asset Management. Data as of 5 March 2018