An Unconventional New Government in Italy

Two months after the Italian election, the country is on the verge of a new government led by the right-wing La Lega and left-wing Five Star movement. While markets take some time to digest the full implications of this unusual tie-up, David Zahn, Franklin Templeton’s head of European Fixed Income, offers his analysis of the political situation.

In our analysis immediately after the Italian election in March this year, we felt a tie-up between Five Star and La Lega (The League), two populist parties at opposite ends of the political spectrum, would be the worst outcome for markets.

Now, two months after voting, it seems likely that those two parties will attempt to form the next Italian government.

How Might Markets React?

So far, markets have reacted relatively calmly to the news.

However, we think there are already signs that this coalition of opposites could try to implement policies that will raise the hackles of the financial markets.

The two sides have been good at talking about how they will spend money and not so good at telling us how they will raise money.

For example, some of the broad themes that have emerged from their discussions include operating a low, flat tax rate, reducing the retirement age (at a time when most other countries are doing the opposite) and introducing a form of universal basic income for the poor.

These are noble causes but they all cost money. Italy already has a fairly large budget deficit. It runs a primary surplus excluding interest payments, but its debt-to-gross domestic product (GDP) is more than 130%. So in our eyes, more spending doesn’t seem to be the answer.

Furthermore, Italy is viewed as having one of the weakest major economies in Europe.