Originally published by AMP Capital
66% of German Social Democrat Party members have backed the coalition agreement with Angela Merkel. This was a clearer vote than had been expected and will now see Merkel confirmed as Chancellor for a fourth term (with the next election not until 2021). It also clears the way for Merkel to work with French President Emmanuel Macron to further strengthen the Eurozone (in areas like a banking union), particularly with the even more pro-Europe Democrats taking control of the Finance Ministry. The trick will be to strengthen Europe but not in a way that further encourages support for the far-right nationalist Alternative for Deutschland.
The Italian election is a lot messier as had been expected, with exit polls putting the populist centre right coalition between Forza Italia, the Northern League and Brothers of Italy ahead on 33-36%, the Five Star Movement at 29.5%-32.5% and the Democratic Party led bloc at 24.5-27.5%, all short of the 40% threshold needed to form government.
- The populist centre right coalition may be given first go at trying to form government and would pose risks in terms of further fiscal deterioration and backsliding on reforms, but based on the exit polls (which may be less reliable than normal given the new electoral system) it’s not clear they will get there.
- A Democratic Party and 5SM coalition may be the best outcome in terms of fiscal responsibility – but would really just mean more of the same muddling along in Italy.
- A populist Euro-sceptic coalition between the Northern League and the 5SM would probably be the worst outcome (particularly in terms of the risk that both would go down the path of trying to exit the Euro) but looks unlikely given their political differences.
- Another grand coalition between the Democratic Party and Forza Italia and others is highly possible and would be a continuation of the current government – and again more muddling along.
The new Italian parliament does not sit until March 23 and after that the President will meet with party leaders and give a mandate to attempt coalition formation. So it may be some time before the final outcome is known in terms of who forms government (or whether a new election is on the way).
The Italian election is unlikely to threaten an Itexit (an Italian exit from the Euro) in the short term (and in any case support for the Euro continues to run high across most of the Eurozone), but it does run the risk of making Italy’s public finances worse than they already are with no progress in addressing Italy’s long-term competitiveness problems. Not great – but probably not enough to threaten the greater European integration agenda that Germany and France are likely to pursue or the favourable fundamentals favouring Eurozone shares (relatively attractive valuations, strong growth and relatively easy monetary policy).
The euro initially rallied on the German news only to fall back to where it ended Friday after the initial Italian election results.
There are no significant implications for Australia, except to the extent that the messy Italian election result adds a bit to the nervousness around global equity markets at present.