Italian elections 2018; a great yawn? Or a great surprise?
28th February 2018
The bond market seems rather sanguine regarding the Italian elections; from the highs in early January, spreads with respect to German bunds have tightened materially, from around +160 basis points (bp) in the 10-year maturity down to 120bp. Only in the last couple of weeks have Italian government bond (Btps) spreads weakened somewhat, up to 135bp.
The (ex-post) rationale for such strong Btps performance is that, according to most strategists, the risk of a worst-case-scenario is extremely low. A worst-case government involving the 5 Stars Movement (M5S) alone, or in coalition with the Eurosceptic Lega Nord (LN) and/or Fratelli d’Italia (FdI), is unlikely according to all of the polls. The consensus is that the new electoral law, a proportional system with a 3% entry barrier and 37% of the seats assigned on a First-Past-The-Post (FPTP) basis, will deliver a hung Parliament. So it is likely a Grand Coalition between the moderates of the centre-right and centre-left camp would be formed; a pro-Europe, market-friendly majority that would exclude the Eurosceptic parties.
According to all of the polls, the centre-right coalition between the centrist Forza Italia (FI) + Noi con L’Italia (NcI) and the right-wing Eurosceptic LN and FdI would most likely NOT get a full majority, remaining some 15/20 MPs short of the absolute majority. They would need to reach 39%/40% from the estimated 35/36% to have a decent chance of getting an absolute majority.
The problem lies that this is according to the current polls! What’s the problem? Well, polls for Italian elections are not always accurate, to say the least. For example, in several elections in the last 25 years, polls have consistently underestimated the support for FI, the party of ex-PM Berlusconi.
Even more strikingly, during the last electoral campaign in 2013, polls were all pointing to a 5% to 7% lead for the centre-left coalition; the actual results were 29.5% for the centre-left, 29.1% for the centre-right… just 0.4% difference, i.e. circa 80k votes, out of the 47M voters.
More on that: M5S was polling at 16% in 2013…the actual result was 25.5%…almost 10% more!
Many FPTP seats, especially in the South of Italy, are close enough that a couple of percentage points in favour of one party would allow M5S to win the seat, or the centre-right coalition to win those 15/20 more seats needed to get a full majority. According to the newspaper La Stampa, in some districts in the southern region of Campania (where Naples is situated) the distance between M5S and the centre-right is as low as a few hundred votes…Campania is “the Ohio of Italy”.
It is likely that today pollsters have a better understanding of the M5S strength, while five years ago the new party had come out of nowhere, but, if history is any guide, we cannot exclude surprises once all the actual votes are counted. The large share of those who have not yet decided, close to 40%, is a further element of uncertainty.
What could be the (negative) surprises, if polls turned out to be incorrect?
- A landslide victory of the centre-right could put to rest the Grand Coalition hypothesis; something the market will not like, especially IF the distribution of seats were to favour the Eurosceptic components of the coalition.
- A larger than expected performance from the M5S in the South would probably eat into the number of FI seats, and may not only deprive the centre-right of the full majority, but also prevent the Grand Coalition from reaching a majority. What would happen next? Negotiations would follow between parties, and the M5S would be a key player, maybe in coalition with the centre-left and the left (should Mr. Renzi be forced to resign by a larger than expected electoral defeat) or in coalition with LN and FdI. New elections would also be a possibility if no coalition could be formed.
How could the market react? Well, as long as the economic outlook continues to improve, even a centre-right government with a large Eurosceptic component could be just a temporary source of uncertainty, but not a fundamental issue. The same reasoning applies to a M5S-led centre-left government. Should the economic outlook deteriorate, however, the market will worryingly scrutinise the new government’s response to the inevitable worsening in the fiscal situation…and react accordingly.
A M5S-led coalition with the other Eurosceptic parties, LN and FdI, would require a major electoral earthquake to materialise, but it would really be THE worst-case-scenario.
To conclude; there are many moving parts, and room for surprise abounds. Even the EXIT polls are not very reliable; in 2013, the first round of exit polls were confirming the expected centre-left advantage, just to be continuously revised down by the official data as actual votes were counted.