Italy’s political crisis drags euro through turmoil

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Since March, Italy has been stranded in political purgatory. The general election failed to find a political group who could muster a majority, and the country was left without a concrete government. Populist parties the Five Star Movement (M5S) and the League – who together attracted over 50 per cent of the vote – attempted to form a coalition. As the parties were appointing their cabinet, the coalition collapsed, leaving the euro in a dangerously precarious position with further elections planned. As of Thursday, the announcement of a reformed coalition restored a semblance of calm to the markets. FXTM staff writer Natasha Keary reviews a whirlwind few days in Italian politics.

The Five Star Movement and the League were previous rivals, sitting on opposite sides of the political spectrum. However, the two parties found common ground in their scepticism towards the EU and views towards immigration. They appointed Giuseppe Conte as government leader and began to propose expensive policies. These included the deportation of 500,000 migrants, a basic monthly income for the poor, and two “flat tax” rates of 15% and 20%. These policies alone were estimated to cost over €60 billion to implement. For a country which holds the second highest debt in Europe after Greece, the financial burden of these reforms troubled economists and financial experts.

It was Conte’s attempt to install Paolo Savona as finance minister which finally sank the planned coalition. President Sergio Mattarella, whose position grants him the power to reject candidates, stepped in and refused Savona’s appointment. Mattarella was convinced that appointing such a Eurosceptic would have terrible consequences for the country. Savona notoriously thought that entering into the euro was a mistake, and often discussed Italy leaving the eurozone. Mattarella believed that Savona’s appointment would undermine investor confidence and undermine the Italian economy.

The decision was met with outrage. Giuseppe Conte resigned, almost willingly in light of accusations that he had made up almost all of the educational material on his CV – including time spent studying at New York University, the Sorbonne, the University of Malta and Yale universities. The Five Star-League coalition which appointed him, however, were furious. Matteo Salvini, the leader of the League party, suggested the president could be impeached and urged followers of the parties to gather in a peaceful protest on June 2^nd.

In the meantime, Mattarella appointed the former International Monetary Fund official Carlo Cottarelli as interim Prime Minister. His government was expected to face difficulty in a parliament in which M5S and the League hold majority. Following a vote of no confidence, another round of elections was due to be scheduled.

Yet, on Thursday evening, talk of further elections abated. The coalition reformed, reappointing Conte as their leader and Savona as minister for European affairs. Salvini will be the Interior and Deputy Prime Minister, and Di Maio Industry and Deputy Prime Minister. Giovanni Tria is the newly appointed finance minister; unlike Savona, he is in favour of Italy remaining in the single currency.

So, what does this mean for the euro?

In the aftermath of the election, the markets responded with caution. Across Europe, the FTSE was down 1.37, France’s Cac 1.3, Germany’s Dax 1.85, and Spain’s Ibex 2.3. The FTSE MIB lost all its previous gains, closing down 2.7 per cent. Overall, short term Italian bonds suffered losses unseen for 26 years.  The euro fell to a six-month low, and yields on Italian debt climbed substantially.

The prospect of another election reignited fears for the euro. Recent events fuelled anti-establishment sentiment, and support for populist parties rose. Polls released last Monday showed that support for the League has increased by five per cent since the election in March. It was widely feared that another election could see one of these parties take the majority, gaining extra support from those angered by the president’s intervention. If this were the case, Italy’s exit from the Eurozone would have been a distinct possibility.

Under the new coalition, ‘Italexit’ or ‘Italeave’ remains a very real possibility. However, after months of chaos, Italy’s government is approaching something resembling stability. This brings comfort to the markets: Italian bonds rose 2.8 per cent on Thursday, and the euro continued its recovery, climbing to $1.17. However, with the new Five Star / League government likely to rail against EU regulations and membership, investors must prepare for further market turmoil ahead.

For cutting-edge market news and reports, visit FXTM’s Daily Market Analysis page.

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