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Italian political issues and the euro

Despite the political upheaval and disagreements between Italy and Germany, the Italians are likely to stay in the euro.

Despite the political upheaval and disagreements between Italy and Germany, the Italians are likely to stay in the euro.

by
Charles Stanley

in Features

10.02.2021

Former European Central Bank (ECB) President Mario Draghi wants to form a new Italian government, to fend off an early election. He and the EU Commission hope he can find a grouping of Ministers and parties that can command a majority on crucial votes in a very fragmented Parliament. Markets seem to be assuming he can.

Italy is having trouble keeping a government. A very split party system, fuelled by their proportional representation system, reflects the general disillusion with domestic politics over recent decades. The continuing high level of unemployment, particularly youth unemployment, has scarred society. The continuing gap between income levels of the economies of the Northern valleys and cities and the southern regions creates political fault lines.

The mosaic of city states is still much in evidence one hundred and fifty years after full unification. Venice has an independence movement. There are plenty of parties who fear an early election should he fail, but they also wish to keep some purity of viewpoint in case an election results from the obstinacy of others. Any coalition deal may be put to a vote of the membership of the Five Star Party, who have been an important part of the outgoing coalition.

The parties

The Northern League has become the most popular political party in the whole country, seeking more Eurosceptic and market-oriented policies. It has, however, lost support to the Fratelli party and now is a bit below one quarter of the vote.

Five Star emerged as a populist contender from the left, wanting more transfer payments and financial support for people and regions in need. It attempted a period in government together with Lega, only to stay as Ministers when the Lega split off to try to benefit from its rising popularity based on tough law and order rhetoric.

Five Star decided to compromise with the pro-governing establishment recognising the difficulties with its old opposition policy of hostility to the euro. The traditional CDU which years ago morphed into Berlusconi’s populist Forza, lost popularity to the more challenging Lega after its own colourful period in power. The Social Democrat Partido Democratico has often been part of a government but struggles to command more than 20% of the vote in elections. It takes a positive pro EU stance on policy.

Of all the splits in Italian politics, the one that matters to markets and forecasters is the split over attitudes to the EU. Action, More Europe and Green Europe are small parties that strongly favour Italy’s European destiny, alongside the Partido Democratico. Five Star now often joins the pro-EU alliance too.

Whilst Forza claims some Eurosceptic views, it is likely to prove to be a supporter of the euro. The recent bust up with the departure of Italia Viva from the coalition government was over how to spend the grant monies coming from the EU for pandemic recovery.

Greek tragedy

Italy has seen how difficult it was for the Greek Syriza party after its original stunning election victory, casting aside both traditional centre left and right parties. Syriza thought that with their mandate for change the EU would give them more flexibility over budgets, more grants and transfers recognising the economic problems the country faced. Instead the EU dug in over the disciplines of the euro scheme and Syriza backed down.

Italy is a lot bigger than Greece, but that is no guarantee playing a tough hand against the euro scheme would go any better for an Italian government than a Greek one. Current polls imply there is no single Italian party that is anywhere near commanding sufficient support to form a strong majority government. The EU would always be able to pick away at coalition partners, in a party system where history shows parties can change their minds over the approach to the EU when under pressure.

This is why our base case assumes Italy will stay in the euro and will do just enough to conform, whilst from time to time complaining and arguing over the restrictions. The main pro-EU parties are not keen on an early election as they are currently unpopular, and even Lega has its misgivings with the loss of substantial votes to Fratelli. This gives Mr Draghi a decent chance of forming a government, getting by in Parliamentary votes where various parties abstain instead of bringing the government down. Should there be a slip and an election occurs the centre right and right are well placed to win – but their coalition would not be likely to seek euro exit. They are more exercised about migration levels.

The issues around the euro remain how to allow transfers between the surplus and deficit countries whilst keeping tough rules on borrowing levels and deficits. The system is kept going by the Target2 balances. Germany now has deposited €1,136bn with the ECB. Italy and Spain have borrowed around €500bn each. As there are insufficient transfer payments and grants going from the richer parts of the union to the poorer, it has to be smoothed by central bank transfers of money at zero interest rates. The commercial banking system has also been the beneficiary of ECB largesse, with €1.79 trillion of low-cost loans to commercial banks from the ECB. The large QE programme has helped keep markets liquid and interest rates near or below zero.

There is more risk in the euro than in a national currency like the dollar or sterling. The individual countries and their own Central Banks in the Euro system cannot print euros to repay their debts or pay their bills in the way a national CB can issue its own currency to meet the nation’s liabilities. That is why Italian politics has to dance to the tunes of the Commission and ECB, and why the current big issue in politics is how to spend the EU money.

Should there be an election which makes the issue the wider one of how much money will the EU give the Italian state or how the rules of the euro can be changed there may be some market jitters, but it is difficult to think it would end up threatening Italian euro membership.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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