Italian election: a game of coalitions

The Italian general election will be held on 4 March. The key to power lies not just in forging allegiances, but navigating complex new electoral laws

Karim Chedid
Karim Chedid, CAIA
Investment Strategist
February 2018

Key Points

  • Our base case is a hung parliament leading to a grand coalition between the major centrist parties, although a surprise populist victory remains a possibility. Read more >
  • We see improving Italian fundamentals as limiting material downside to risk assets from political developments. Read more >
  • The election occurs against a backdrop of an improving Italian economy and strong equity performance over the last 12 months. Read more >

The election will be fought between three main blocks:

  1. Centre-right: A coalition of parties including Forward Italy (Forza Italia), Northern League (Lega Nord) and Brothers of Italy (Fratelli d’Italia), led by former Prime Minister Silvio Berlusconi for Forward Italy and Matteo Salvini of Northern League.
  2. Centre-left: anchored by Democratic Party (Partito Democratico or PD) with a few small parties, PD being led by Matteo Renzi.
  3. Independent anti-establishment movement: Five Star Movement (Movimento 5 Stelle or M5S) led by Luigi di Maio, which has positioned itself as distinct from other parties and resistant to forming coalitions with them.

The challenge for each of these parties is a new, untested electoral law which means that for the first time since 2001, voters have the option to vote not just for a party, but for a candidate in a first-past-the-post race in their local constituency (Politico, 15 January 2018). One third of the seats are assigned by the first-past-the-post (uninominal) system and the remainder according to a full proportional system. Theoretically, even as little as 40% of the votes, depending on the performance of uninominal colleges, could be enough for a single party or coalition to get an absolute majority in Parliament.

Find out more: The Italian election explained

The political landscape

Five Star is currently the largest party in Italy, especially after severe internal infighting and struggles to come up with a clear message have launched the PD into free fall in the opinion polls. The centre-right coalition is well ahead of both, in large part due to Berlusconi’s involvement, even though he cannot take up public office himself due to a 2013 tax fraud conviction. However, while they may be closer than any other coalition or party to a majority, they will likely struggle to get enough votes in the south and so we maintain that the most likely outcome is a hung Parliament, followed by lengthy negotiations between the political parties.

Our base case, albeit with low conviction, is that a hung Parliament would most likely lead to a grand coalition between PD/Forward Italy and other centrist parties, while the possibility of a second election exists but is unprecedented during the Second Republic. We see other outcomes, such as a national unity government supported by all parties, or an anti-establishment alliance with Five Star and the Northern League or PD, as less likely.

However, it must be noted that given the new system and a high proportion of undecided voters, the polls are even less likely to be reliable than in the past. The impact of a higher turnout is unclear, although on balance tends to favour establishment parties. A surprise showing by populist parties could lead to new questions about the durability of the eurozone.

Policies and promises

All the parties are making electoral promises which appear somewhat unrealistic such as a universal income proposal, a flat tax for households and companies, and the partial roll-back of labour market and pension reforms. However, even if these promises are unlikely to materialize in their current form, it suggests that spending and therefore the government deficit will increase.

Although the Northern League and Forward Italy are seemingly playing to a supporter base that is discontent with current levels of immigration, on the key question of EU stance, the pro versus anti-Europe debate that has underpinned other recent European elections, does not appear to be playing a role in this campaign. As recently as January, even the anti-establishment Five Star indicated that plans for a referendum for exiting the eurozone would be seen as a “last resort” (Bloomberg, 13 February 2018).

The Italian economy by numbers

It should not be forgotten that although it lags the rest of the eurozone, the Italian economy looks to be doing well. These elections are taking place against an improving economic backdrop: its recovery from its worst recession since World War II has gained pace.


Growth: The Bank of Italy projected recently that the economy will expand by 1.5% this year and that growth should remain above 1% over the next two years, citing rises in household income and declines in firms’ spare capacity as signals of higher consumption and investment.


Public debt: Public debt has stabilized at approximately 132% of GDP (Bloomberg, 10 February 2018).


Current account: Italy keeps running a sizeable and stable current account surplus at 2.8% of GDP, (The Bank of Italy, November 2017).


Foreign investment: Italy’s net international investment position, though still negative, has improved from approximately 35% of GDP in 2008 to less than 10% in Q3 2017 (National Institute of Statistics, Italy (Istat), 18 January 2018).


Manufacturing sector: Evidence points to a broad recovery, with the Manufacturing PMI hitting a near seven-year high of 59 in January and remaining in expansionary territory since a brief contraction in August 2016 (IHS Markit, January 2018).


Banking sector: Although still overloaded with non-performing loans (NPLs) – loans overdue by more than 90 days – the flow of new NPLs fell to 1.7% in Q3 of 2017, below pre-financial crisis levels of 2006-2007. Stock of NPLs fell to 8.4% of total loans in June 2017 from around 9.3% at the end of 2016. (The Bank of Italy, Istat and BlackRock Investment Institute, 18 January 2018.)

What might this mean for markets?

Markets have shown little reaction to Italian political risk, despite the uncertainty of the outcome and lack of clarity around what policies or changes any outcome would bring. There may be a modest increase in volatility as the election approaches, but “tail risk” outcomes, such as a far-right government, seem unlikely as no party currently looks like it will emerge with a clear mandate. Given this uncertainty, we see reduced likelihood of fiscal tightening in any case and even the potential for the partial rollback of structural reforms.

Notwithstanding the muted geopolitical risks, we are underweight European fixed income overall – across sovereigns and credit on account of ECB interest rate and asset purchase policies. Although we are neutral on broad European equities, the fact that Italian fundamentals appear to be on an improving trend limits the material downside to risk assets. Despite downgrading to neutral, European earnings have still been strong in the face of the Euro appreciation over 2017. Q4 2017 earnings growth of 15% and robust expectations for 2018 point to a strong backdrop for eurozone equities (BlackRock with Thomson Reuters data as at 16 February 2018).

Italian equities have outperformed both the eurozone and U.S. equities over the past 12 months, as shown below, supported by the region’s above-trend economic expansion. Currently trading at 20% valuation discount to their 5 year average Italian equities do not look expensive relative to their historical norms (BlackRock, with data from Bloomberg, 20 February 2018).

Index Name Currency 31/12/2012 - 31/12/2013 31/12/2013 - 31/12/2014 31/12/2014 - 31/12/2015 31/12/2015 - 31/12/2016 31/12/2016 - 31/12/2017
FTSE MIB EUR 19.70 2.37 14.97 -7.46 16.33
MSCI EMU EUR 23.36 4.32 9.81 3.80 12.49
S&P 500 USD 31.55 12.99 0.75 10.18 21.10

All data sourced from Bloomberg, correct as at 14 February 2018. Performance is expressed in base currency of each index and expressed on a total return basis with net income reinvested. The chart shows performance over the last 12 months, rebased to 100 on 14 February 2017. The table shows a 5-year record of discrete annual returns. Index performance is for illustrative purposes only and does not reflect any management fees, transaction costs or expenses. The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results.

In the event of our base-case scenario, a hung parliament, the market response will likely depend on the performance of the establishment versus the anti-establishment parties. A strong anti-establishment vote could have the potential to affect risk assets but impact should be limited as at the time of writing, we believe that the most likely outcome of coalition talks would be a PD/FI grand coalition with the explicit or implicit support of the small parties.

Certain uncertainty?

The bottom line: Markets are familiar with political uncertainty in the eurozone, but the fact that economic fundamentals have been on an improving trend may help limit any downside for Italy.

The opinions expressed are as of 20 February 2018 and are subject to change at any time due to changes in market or economic conditions. The above descriptions are meant to be illustrative. There is no guarantee that any forecasts made will come to pass.

Investing in Europe with actively managed funds and Exchange Traded Funds (ETFs)

If you decide you would like gain exposure to the broader European market, an ETF or an actively managed fund could be a way of doing so.

Investors should note that where investment risk is concentrated in a specific country or region, funds are more sensitive to any localised economic, market, political or regulatory events.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any financial instrument or product or to adopt any investment strategy.