Italian Election Outlook and Why We Don’t See an ECB Rate Hike Before 2020

The upcoming Italian election is not attracting the same sort of attention among investors as votes last year in France and Germany. For that very reason, David Zahn, Franklin Templeton’s head of European Fixed Income, believes an unexpected result might provoke an outsized market reaction. And while investors seem more preoccupied with the trajectory of eurozone monetary policy, Zahn believes there are good reasons to think the European Central Bank will hold off until 2020 before pushing interest rates up.

Italian Political Uncertainty

Most polls suggest there will be no outright winner in the upcoming Italian general election, due to take place on March 4. We think the most likely outcome is either a technocrat government or a grand-coalition—neither of which we’d expect to have a dramatic impact on bond markets.

However, it could be a different story if one group were to win enough seats to form a government, particularly if that group was the coalition of center-right parties currently riding high in the polls.

The final opinion polls published ahead of the election suggest the coalition of center-right parties (that includes the Silvio Berlusconi-led Forza Italia) could win the most seats. In contrast to traditional center-right dogma, the Berlusconi coalition’s manifesto calls for increased spending and a larger Italian budget.

It currently looks unlikely to reach enough seats to win an absolute majority, but if it did creep over the line, that outcome could have negative repercussions on Italian debt. The country’s central bank would likely be issuing more government bonds (BTPs) at a time when one of the biggest buyers, the European Central Bank (ECB), is scaling back its purchases of government debt.

Modest Volatility and Rising Yields in Europe

Looking more widely, we’ve seen little evidence so far that contagion from the global equity pullback at the beginning of February has spread into fixed income markets.

In European corporate markets, there’s been some modest volatility (more at the index level) and we’ve seen some spread-widening, but nothing that’s overly concerning to us.

European sovereign bond yields are higher this year and have risen a little more quickly than we expected. We felt they would rise in time, but while economic growth has been strong in Europe, inflation remains quite low. However, there are some signs of higher inflation coming through in the data.