Resignation of Italian ministers unlikely to result in early elections – Italy’s former prime minister and the leader of centrist party Italia Viva, Matteo Renzi, has announced that his party will no longer be part of Italy’s coalition government. Reasons for the resignation of the three Italia Viva ministers are, amongst others, disagreement about prime minister Giuseppe Conte’s investment plans, which will be financed by the EU Recovery Fund. Moreover, Mr Renzi disapproves of the way in which Mr Conte is dealing with the pandemic more generally. Despite Mr Conte’s resulting loss of a majority in parliament, we judge that snap elections will probably not be the outcome of the political crisis. There are early signs that Mr Conte will be able to find enough support from non-coalition members of parliament (potentially even from Italia Viva) to keep his government standing. Alternatively, if Mr Conte fails to find enough support, president Sergio Mattarella could succeed in building a new coalition government in order to avoid new elections. In any case, there are no signs yet that Mr Conte is contemplating to resign or new elections will be held as long as the country is suffering from health and economic hardship during the pandemic. Indeed, it is nobody’s interest to have early elections. The current government parties would likely not win in such an election with the chances of a majority for a right wing coalition significant. In addition, it is not in the country’s interest to have an election during a crisis, so the President will also work hard to avoid this.
Italian yield spreads to tighten again although currently priced in political risk premium seems justified – Even though the probability of early elections seems rather small at this stage, the consequences would be significant. Right wing Eurosceptic parties Lega and Brothers of Italy are doing well in the polls and would likely gain power. Therefore, the recent rise in Italian yield spreads over Germany seems justified, and we expect the spreads to remain elevated for as long as this political uncertainty lasts. However, we don’t expect snap elections to take place under our base case. Consequently, we expect the recent rise in Italian yield spreads to reverse once Mr Conte has found new support in parliament or a new coalition has been formed, which might take several weeks.
Looking at the longer term, we expect the Italian 10y yield spread to gradually tighten to about 80bp by the end of 2021, as we judge that the spread is too high given Italy’s current credit rating as well as the government’s interest payment capacity, which has been improving over the past years and is expected to improve further despite rising debt stock. In addition, we continue to expect large-scale ECB purchases and the EU Recovery Fund to provide a positive backdrop for Italian yield spreads.