Italian election results carry risks to the Euro

Executive summary

A new leader emerged from the Italian election, Giorgio Meloni. Matteo Salvini and Silvio Berlusconi will support her in forming a government. This will be Italy's first time experiencing a far-right government since World War II. The Euro and European assets carry an additional risk if the new Italian government clashes with the European Union (EU) to distribute European recovery funds. We expect an exchange rate of 90 cents to the Euro within the next 12 months. Therefore, we continue to recommend an underweight position in overseas equities, especially in Europe.

What happened

Giorgia Meloni, the leader of Brothers of Italy (Fratelli d'Italia - FdI), is expected to form a coalition government and become Italy's first female Prime Minister. In the 2018 election, her party garnered only 4% of the vote, but this time, more than a quarter of Italians supported her. Her party is expected to be backed by Matteo Salvini's League Party and Silvio Berlusconi's Forza Italia. The bloc failed to achieve a two-third majority that could amend Italy's constitution.

Since World War II, Italy has had over 70 governments, making the average life expectancy of an Italian government around 1.1 years. With his credibility as previous President of the European Central Bank (ECB), Mario Draghi, former Prime Minister, was a beacon of hope for Italy and the country's strained relationship with the EU. His tenure lasted a little less than two years, still higher than the average tenure of an Italian Prime Minister.

Meloni's FdI, due to their conservative, nativist, and anti-immigration stance on domestic issues, is labeled as a far-right nationalist party by many political commentators. During her election campaign, Meloni frequently praised Hungary's Prime Minister Victor Orban and Poland's former Prime Minister Jaroslaw Kaczynski, Europe's two most notorious right-wing leaders. She is against the European progressive mainstream, but it is not yet clear if she is anti-EU establishment. In a video released during her campaign, which relayed her agenda in four languages she speaks (French, English, Spanish and Italian), she had a more conciliatory approach towards the EU.

Our take

It is all about “how to spend the recovery fund money”

Italy is the 3rd largest economy in the Eurozone and chronically a sluggish one. Since 2000, Italy's real economic growth rates averaged only a quarter percent per year, falling well below Eurozone peers. Economically, the best thing that happened to Italy since the introduction of the Euro is the €750b European Recovery Fund, with almost €200b of the fund's proceeds allocated to Italy. The proceeds are primarily grants or low-interest rate loans and can therefore lift Italy's prospects without creating much fiscal burden, but the EU can add conditions to these proceeds. Italy already made pledges during the Draghi times, and the EU is not sympathetic to last-minute changes. Meloni may dare to renegotiate critical reforms that are conditions to receiving EU funds, but that action could jeopardize Italy's access to necessary funds.