'Political Risk Is Back Roaring': Managers Warn Election Result Is 'bad News' For Italy

A hung parliament remains the most likely result with ex-Prime Minister Silvio Berlusconi's centre right coalition falling short of the 316 seats required in the lower house of parliament for a majority by only winning 233 seats.

Anti-establishment parties M5S, which will become the country's biggest party, and the League posted stronger-than-expected results with 32% and 18% of the vote respectively, making it a possibility for the two to form a government.

The governing Democratic Party - headed by former Prime Minister Matteo Renzi - had a terrible night, with the party winning less than 19% of the vote.

As a result of the surge in popularity of extremist parties, the FTSE MIB slumped 1.2% to 21,640 points while Italian 10-year government bonds widened 10 basis points to 2.14%.

Italian banks were also hit with UniCredit and Intesa falling 3.4% and 2.5%, respectively.

However, the result is yet to spread to European markets with the euro level with the dollar at €1.233.

Euro-risk

Despite the limited impact of European politics on markets last year, Timothy Graf, head of macro strategy for EMEA at State Street Global Markets, said the unexpected strong performance of the M5S has brought threats to the eurozone to the fore.

Furthermore, he said the euro-scepticism shown within the bloc as a whole could re-introduce the "existential threat" to eurozone stability.

"Forming a government has many challenges, but this result could dent the strong consensus support the euro currently enjoys. Italian bond spreads also have scope to widen modestly from current levels," Graf said.

Antoine Lesné, head of EMEA strategy and research for SPDR ETFs, added the election result was a blow to the strong consensus about the benefits of the euro.

"Political risk is back roaring," Lesne said. "Italy was always going to be the country where some of the Eurozone construction issues would be the most acute.

"This may also inevitably reverberate onto other euro assets at least until the market focuses on the next important European event this week, namely the European Central Bank."

Italian Elections 2018: 'The country is a euro-killer'

Echoing this view, Jonathan Fletcher, head of European equities at Brooks MacDonald, said M5S's strong performance had once again led to the re-emergence and impact of populist politics.

"This will again lead to questions over the eurozone's ongoing sustainability," he said. "We will be watching the coalition negotiations closely for signs that they may start to drive a contagion effect among the continent's bond and equity markets, as was the case during the European sovereign bond crises earlier this decade."

Reforms

Ewout van Schaick, head of multi-asset at NN Investment Partners, said the emergence of a weaker government would hinder the country's ability to pass the necessary reforms required for growth.

He added the strong performance of Matteo Salvini's League party would mean the centre right coalition, if formed, will take a more populist tone while also warning a coalition between the M5S and the League remained an unlikely tail risk.

"A hung parliament could be bad news for Italy, as it will likely lead to a weak government that will not be able to pass important reforms," he said.