Confidence key for growth
Confidence is key for growth to continue to perform well; the economic recovery is mainly being driven by domestic sectors, but recent GDP performances (1.5% in 2017) remain below the EU average (2.5%). A hung parliament or a fragile coalition could be clear risks in terms of future economic performances: if reforms are stopped or reversed by the next government, it will be difficult for Italy to rebuild higher potential growth over the medium term and to actively participate to a renewed EU project, as suggested by Emmanuel Macron and Angela Merkel. Cyclical growth has strengthened but structural growth remains low: Italy is currently showing a current account surplus (2.7% in 2017) and its fiscal deficit is below 2%. These positive results have to be consolidated by a clear economic policy that favours ongoing reforms (labour, public sector, new technologies and services) and maintains the long-term goal of better-balanced public finances. Participation in the EU is also at the centre of political debate in Italy, but the problems attached to Brexit should contain risks of an “Italy-exit”.
Equities supported by positive outlook on earnings
Market views on Italy remain constructive, as long as the recovery is in place and the banking sector continues to reform. Fears about the banking sector have penalised the market in the past, but the outlook has improved and the sector has delivered a strong performance year-to-date.
Moreover, EPS growth in Italy looks sustained (16.8% for 2018 according to the IBES consensus), while valuations remain relatively moderate compared with other developed and European markets. The growth trend should continue to fuel market performance, unless a major negative surprise arises as a result of these elections.
Bond market remains calm on the eve of elections
No major systemic risk has been priced into the bond markets ahead of these elections. The 10-year spread on bonds over German Bunds has narrowed in recent months, while volatility rose across all asset classes. In January, the ECB reduced its purchases of Italian bonds in parallel with the overall reduction of its QE programme (EUR 30 bn per month), but it has increased the duration of the Italian bonds purchased. The ECB’s purchases have helped to reduce the cost of capital in peripherals since 2012; when this process ends (probably at the end of 2018), Italian fundamentals will take the lead in driving bond yields and spreads.
Patrice Gautry
Chief Economist