Two events will dominate news flows next week: the reaction of the Italian political scene to the outcome of the constitutional referendum on 4 December, and the meeting of the ECB’s Governing Council….
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Intesa Sanpaolo – Research Department For professional investors and advisers only
The ECB’s possible decisions are discussed in a dedicated section of this document. For what concerns the referendum, the markets are already pricing in a heightening of political uncertainty. However, the importance of the vote has been overplayed. Other, more important processes are currently under way.
In the next few days the financial markets will have to deal with two events that are perceived as being very important: the constitutional referendum in Italy on 4 December, and the meeting of the ECB’s Governing Council on 8 December. As explained in this week’s dedicated analysis, the meeting of the European Central Bank is very important, as it should announce whether the purchase programme will be extended to beyond March 2017, and how. In theory, on the other hand, the Italian constitutional referendum should not have been of any particular importance for the markets, as had been the case with other referendums in the past, which failed to awake any interest among investors. However, expectations for a potential “No” victory to be followed by a government crisis have significantly raised the level of attention. In turn, the risk of a government crisis, once included among the possible scenarios in light of survey data which awarded a lead to the “No” camp, heightened uncertainty over the future evolution of economic policy, and on the outcome of the process of restoring distressed banks to health. Even worse, given the correspondence with an uncertain phase for the APP, critics convinced that Italian debt is unsustainable, which were silenced by the 2012 reversal, are speaking up again. Greater investor caution with respect to country risk in Italy has translated into a wider spread against the Bund, which has not only cancelled the benefits of the APP, but has grown to around 20bps above the theoretical level (pushed up by the widespread increase in medium and long-term rates).
However, the importance of the vote on 4 December has been overplayed. One of the discriminating factors in terms of subsequent developments will obviously be the evolution of the APP, which depends on the ECB. However, there are other processes and decisions in the making in Italy, which will be decisive. Let’s assume for a minute that market consensus is right and that next week a government crisis breaks out. Excluding the unlikely event of an immediate dissolution of Parliament, the crucial issue will initially be how the crisis is solved. The ability to guarantee a government in office should smother the absurd expectations by which the country could question its monetary union membership (incredibly, this month’s Sentix survey of investors attaches a probability as high as 19% to such an event in the next 12 months).
After this first important step, the perception of country risk in Italy will be tied to other processes. First of all, Parliament’s ability to define an electoral system that strikes a balance between the need to assure governability and the risk of a euro-sceptic drift; second, the ability to make tangible progress in restoring distressed banks to health. For a number of reasons, including the fact that the 2017 Budget has already been drawn up, and the nearing of the natural end of the legislature, 2017 will be a transition year in terms of governing the country. And this is the very reason for which, by contrast, defining an electoral system will be important: markets have realised that the electoral season in 2017-18 will also involve Italy – in addition to Holland, France and Germany. Lastly, tangible progress in the stabilisation of those banks facing hardships would remove another important source of uncertainty clouding the future evolution of the Italian economy. None of these issues are impossible to solve. Furthermore, two will have to be tackled and overcome whatever the outcome of the vote on 4 December. Which is another reason to believe that the markets may have paid too much attention to them in the past few weeks.
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