Italy remains a source of tension - BBH

Italy remains a source of tension, but its problems remain localized according to the Research Team at BBH.  

Key Quotes

“We do not see the rejection of the referendum as part of the Brexit-US election axis, and the 40% that voted for the referendum is a sufficient block to elect the next Prime Minister.  We would suggest the local elections earlier this year, in which the Five-Star Movement won in Rome and Turin, is a more revealing sign of its ascendancy.”  

“Italy's foreign minister Gentiloni will replace Renzi as Prime Minister provided he can put together a government that can win a confidence vote.  A broad coalition government needs to be in place by the middle of the week, to allow Gentiloni to represent Italy at the EU Summit that begins Thursday.  Gentiloni is the fourth unelected Italian Prime Minister.  For now, Italian asset are doing fine with Gentiloni forming a caretaker government.”

“There are three main tasks for the caretaker government: prepare for elections, make the necessary decisions to address the simmering banking crisis, and continue reconstruction of the areas devastated by the recent earthquakes.  An election before the Dutch election in March seems optimistic, but still the table is set for quite a political spring in Europe (Holland, Italy and France, UK likely triggering Article 50, before German elections in the fall).”

“The Italian premium over Germany has been trending higher all year.  It began below 100 bp and is now at 167 bp, having been a little above 185 bp in late November.  Italy's 10-year bond yield is up 45 bp this year.  Spain's is off 25 bp.  However, Italy can still borrow money at negative interest rates going out two years.  The current minus nine basis points compares with positive ten basis points in late November.  The Italian bank stock index fell 2.25% before the weekend, but it still closed higher on the 12.75% on the week and 18% over the past two weeks.  Perhaps, if necessary, the interregnum government can take the unpleasant step of seeking ESM support, which could otherwise tarnish Renzi's comeback.”

“Renzi (not Grillo, the head of the 5-Star Movement) is likely the odds-on favorite of the next election at this juncture.  The Constitutional review of the new electoral law for the lower chamber after the former law was disallowed will take place in late January.  If the new electoral law is rejected by the Court on grounds that giving a bonus to the largest party is not consistent with representative government, it would further bolster Renzi insofar as it favors coalition building, and this is a critical weakness for the Five-Star Movement.”