Even for the Eurozone’s weakest, some hope for the future

BY DEB SHAW | 

  • Sicilian elections failed to upset the status quo, as Berlusconi returns to Italian politics
  • Despite rising support for Five Star Movement, electoral system favors incumbents
  • Euro to remain supported between accelerating growth and limited political risks

The recent regional elections in Sicily was seen as a ‘dry rehearsal’ for the upcoming national elections last year. According to Reuters, Sicily is seen as a bellwether of national politics. Thus the showdown between the Five Star Movement and the center-right bloc led by Forza Italia (and bolstered by the recent return of Silvio Berlusconi to politics) was watched with keen interest by investors. As the Five Star Movement and other populist parties have been gaining in popularity, there is a risk that the next Italian national government will be fundamentally opposed to the European Union. This is particularly true for Sicily, one of Italy’s poorest regions.   

Following the Sicilian elections, the center-right candidate (Nello Musumeci) won the largest share of the vote and prevented populist parties from gaining power. Thus Sicily’s next government will once again be formed by political parties who broadly support the status quo. The vote also marked the stunning comeback of Berlusconi, who has been tainted by many scandals in the past.

 

Political risks from Italy contained, but national elections still looming

For investors, one of the biggest political risks to the Eurozone appears to be contained for now. Italy has been beset by both poor economic growth and a big influx of refugees that has resulted in more than 500,000 arrivals in the last three years according to the Financial Times. Slow growth and significant cultural changes are ideal for populist movements, and several political parties (including the Five Star Movement) have sprung up in response.

Despite the outcome of the Sicilian election, support for the Five Star Movement continues to climb. According to an IPSOS poll in Corriere della Sera (an Italian newspaper), the Five Star Movement leads with 29.3% of preferences followed by the Democratic Party at 24.3%. Berlusconi’s Forza Italia came in third at 16.1%. While the risk of the Five Star Movement forming a national government is low as Italy’s electoral system favors mainstream political blocs, there is a risk that anti-establishment parties join forces in order to form a coalition government.

For now, political risks from Italy are in the background following the Sicilian vote. Expect concerns to start rising closer to May 2018, the ultimate deadline for a national vote.

 

Economic optimism takes over from worrying political risks

In a previous article on the future of the euro, we argued that politics and economics would drive the euro, as the ECB remains on pause until the second half of 2018. With limited political risks today, investors in the euro have been focused on the Eurozone’s strong GDP growth in 2017. Even Italy, the Eurozone’s Achilles heel, has done well this year. A comparison of GDP growth between Germany (one of the strongest economies in the region) versus Italy are shown below for reference:

Italian economic growth not far behind Germany today

11-15-2017 Italy v Germany GDP
Source: Bloomberg, MarketsNow

 

Recent Q3 GDP growth data from both Italy and Germany has been encouraging. With Q3 GDP growth coming in at 1.8% year-over-year, Italy is no longer far behind Germany (2.3%). While the future looked hopeless in late 2012, the fact that growth is moving in the right direction means that Italians have some reason to feel optimistic. While significant challenges to Italy’s economy (including its ailing banking system) remain in the background, accelerating growth bodes well for the immediate future.    

 

Enjoy the euro upswing while it lasts

Given the current background of limited political risk and accelerating GDP growth, the euro is enjoying a rare moment in the sun. As risks from anti-establishment political movements in The Netherlands, France and other member  countries fade into memory, the focus will remain on economic data. As growth continues to accelerate, we thus expect the euro to stay supported. Yesterday, we upgraded our short-term outlook on the common currency to bullish (with the caveat that the euro is looking overbought in the short-term). 

Risks to our outlook include a breakdown of the ongoing German coalition talks and an escalation in the Catalan independence movement.

Topics: Euro

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