Following the unsuccessful final round of coalition talks, Italian president Mattarella declared that the process to form a government had failed. Mattarella’s preferred option remains to install a fixed-mandate technical government tasked with the approval of the 2019 budget and a new electoral law. Both Lega and MS5 – which together have a parliamentary majority – swiftly rejected this option and called for early elections.

The risk of fresh voting had an immediate knock-on effect on markets with the 10-year Italian Government Bonds (BTP) experiencing the largest sell-off since last December  leading to a 10 basis points rise to around 1.87% – the highest level since March 28. The news also spilled over Italian stocks, with the FTSE MIB index receding by as much as 2.4%. The markets are also observing today’s widening BTP-Bund spread after recently hitting the lowest point in the last two years.

The political turmoil in Italy comes at an unfortunate time as signs of a slowdown in Germany – Europe’s economic powerhouse – start to emerge. This and an automatic increase in VAT in autumn, in the context of a hung parliament, could easily throw the Italian economy in a recession.

This article has been submitted by the economic analysis unit at Diplomatique.Expert