The Italian electorate is not enamoured with austerity, Ashburton says

After exit poll confusion and demands for recounts by Berlusconi, it is still not certain whether Pier Luigi Bersani is able to form a government or if we are heading for another round of elections. However, one result was clear last night: the Italian electorate is not enamoured with austerity. Derry Pickford, Macro Analyst at Ashburton comments

In the vote for the lower house, Comedian Beppe Grillo’s Five Star Movement (5SM) got the biggest share of any single party at nearly 25.6% of the vote. However, 5SM was behind Bersani’s “Common Good” coalition of social democratic socialist and green parties, which totalled 29.6%, and Berlusconi’s coalition of conservative nationalist and regional parties at 29.2%.

This meant that the majority of Italians voted against austerity. The only group advocating pure ECB orthodoxy, Monti’s centrist coalition, got 10.6% of the vote. Bersani takes the lower house by virtue of leading the biggest coalition (54% of seats automatically go to the largest coalition regardless of the margin of victory). Although both Bersani and Berlusconi did marginally better in the share of the Senate vote, Bersani failed to get a controlling majority either alone or with Monti’s centrists. This will make formation of a new government tricky.

The best case for Bersani is that he is able to build a grand coalition; the worst is that we get yet more elections and that Berlusconi and Grillo win a majority. An alternative scenario is that Bersani may be able to tempt some members of the 5SM with promises of reforms that tackle corruption and vested interests as well as improved internet infrastructure.

Both Grillo and Berlusconi have flirted with the idea of a referendum on Italy’s membership of the Euro and this is what really scares markets. Any question about Italy’s commitment would raise “convertibility” premia. This should mean that the ECB would step in with Outright Monetary Transactions (OMT) but OMT is conditional on Italy following a path of fiscal consolidation. This could set up a dangerous game of chicken between a future Italian administration and the ECB, with Merkel on the other side.

So far, European policymakers have managed to avoid disaster and we still think they will do the right thing eventually, but in the mean-time markets could have a real fright.

Ratings agencies are notoriously backward looking. Their reputation was made even worse by the financial crisis when AAA tranches of structured securities became impaired.

The decision to downgrade the UK, leaving only Canada and Germany in the G8 with AAA ratings by both Moody’s and S&P, is unlikely to enhance their reputation for economic coherency. When countries issue their debt in their own fiat currency it is rare for them to explicitly default. They can de-facto default by inflating the purchasing power of that debt away.

The poor performance of Sterling, down nearly 7% since the middle of December, reflects reduced confidence on the real rate of return on UK assets. However, Moody’s are modelling the probability of explicit default and it seems unlikely the chances of that have significantly increased despite the poor data coming out of the UK over the last few months. When S&P downgraded the US back in 2011, this was arguably more justified. The US debt ceiling cap meant that the executive could be forced into having to choose to break one law and choose defaulting on its debt.

The UK tends to issue relatively long dated debt, which reduces its roll-over need in any one year. The chances of explicit default seem low. Markets have showed what they think of Moody’s assessment by lowering the ten year yield by nearly 10bps.


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