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The new Italy becomes a risk for the euro

The verdict of the financial markets on the Italian elections is clear: thumbs down.

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The new Italy becomes a risk for the euro

The verdict of the financial markets on the Italian elections is clear: thumbs down. Yields on Italian 10-year government bonds rose to 4.46 percent on Monday morning, the highest level since September 2013, the time of the euro crisis. And they took the euro hostage. It hit a new 20-year low at $0.9565.

The election victory of the historically unique legal alliance since the Second World War led by the Eurosceptic "Brothers of Italy" with their boss Georgia Meloni unsettled investors. They fear an avalanche of spending from the new government, a dispute with the EU and a departure from the reform course taken under Mario Draghi. However, the oath is not likely to come until spring, and above all, Europe has a decisive means of exerting pressure.

"In addition to all the negative news, the shift to the right in Italy is bringing political uncertainty to the euro zone," says Jochen Stanzl, chief market analyst at broker CMC Markets. Jörg Zeuner, chief economist at Union Investment, agrees. "Looking forward, the uncertainties surrounding the third-largest economy in the euro area will increase," he says. "Italy is becoming a politically wobbly candidate again."

The right-wing alliance had shown itself to be surprisingly moderate during the election campaign. There was no more talk of leaving the EU. However, the “Italian brothers” generally do not think much of cooperation and collaboration, relying more on national solo efforts.

"Investors' biggest concern about Meloni is whether the new far-right Italian government will deviate from the reforms Draghi has initiated," said Ipek Ozkardeskaya, market analyst at broker Swissquote. Draghi managed to get the EU on Italy's side, and this not least brought the country the enormous sums from the reconstruction fund. "Draghi knew well how to dance with the other Europeans," says Ozkardeskaya. "That doesn't apply to Meloni."

In any case, she does not want to continue the structural reforms started by Mario Draghi. The markets also have doubts as to whether the money from the growth fund is being channeled into the right channels, says Thomas Gitzel, chief economist at VP Bank.

"Once the coalition is in place, the market will watch with eagle eyes what attitude the new government takes towards the EU," says Daniel Lenz, analyst at DZ Bank. "An emerging dispute, even if it is not about fiscal issues in the narrower sense, would certainly lead to an increase in risk aversion." .

But not only the possible dispute with the EU worries the investors. "The right-wing alliance is forcing a relaxed fiscal policy," says Gitzel. “There should be tax cuts. A reform of income taxation is planned, which is to be converted to a flat tax, which corresponds to a uniform tax rate for everyone.” This is likely to increase the budget deficit significantly.

However, Matteo Ramenghi, chief investment strategist at UBS WM in Italy, is pinning hope on the fact that the balance of power within the legal alliance has shifted in favor of the "brothers of Italy", while at the same time the Lega lost. This could have an impact on future economic policy. "Unlike the Lega, Italy's brothers repeatedly spoke out against an expansive fiscal policy during the election campaign," he says.

Therefore, in the next few weeks it will be crucial who will prevail in the formation of the government and who will fill which ministerial posts, especially the Ministry of Finance. This will take a few weeks. "The Meloni administration will hardly be able to take over government business in Rome before the end of October," says Jörg Zeuner.

Before the Christmas break, there is therefore little time for drastic changes in course. In addition, the alliance will not want to jeopardize the transfer of the third tranche from the Corona reconstruction fund of 19 billion euros, which is due at the end of the year.

But from spring 2023, Zeuner expects increasing uncertainty. "Then there are various dates that should become the litmus test for the new Italian economic and European policy."

Disputes could arise in particular when the EU assessed Italy's budget, because a new government in Rome that was willing to spend more would then come up against the EU's Stability and Growth Pact, which will apply again from 2024 - a set of rules that is currently still suspended Meloni but never held much.

Jochen Stanzl warns that the development of yields on Italian government bonds will become a yardstick for the uncertainty that is spreading on the market. The increase in these does not cause Rome any problems, because the country's debt is structured for the long term so that only around an eighth of it has to be refinanced each year, so the increase in yields only has an effect very slowly. In addition, the high inflation ensures that the relative debt level falls by itself.

However, all this will no longer apply if interest rates for Italy rise to the level they had already reached during the euro crisis, i.e. to seven percent or even higher. The question will then be whether the European Central Bank will intervene.

Jochen Stanzl thinks it's possible that investors want to test exactly that. However, whether the ECB intervenes will depend heavily on the behavior of the government in Rome. The central bank thus has the decisive means of pressure in its hands to force Italy's government back on the path of fiscal virtue - this is exactly what happened during the euro crisis. The question is whether the ECB will use this leverage again this time.

"The next few months will bring clarity," says Jochen Gitzel. However, the time until this clarity is achieved is likely to be marked by new disputes and new tensions. "Until then, the air will remain thin for the euro."

"Everything on shares" is the daily stock exchange shot from the WELT business editorial team. Every morning from 7 a.m. with our financial journalists. For stock market experts and beginners. Subscribe to the podcast on Spotify, Apple Podcast, Amazon Music and Deezer. Or directly via RSS feed.

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