European Economic Community
Talks on the formation of a populist coalition government in Italy have dominated headlines for the past week. Following a closely watched and ultimately as yet inconclusive election in Italy that took place over two months ago, a potential coalition between the ‘Five Star’ and ‘League’ populist parties appears to be on the cusp of fruition. Thought to be the worst possible outcome of an already difficult situation, the coalition is already wreaking havoc on Italian equities, bonds and the Euro in general.
The Five Star Movement, which claimed over 32% of the vote in March, represents a highly anti-establishment and disruptive party. Italy’s ‘Lega’ party in turn took the third highest percentage of the vote, 17.69%, increasing its share of the vote by an immense 13.59% versus its previous performance. The League is a far-right party, and within the coalition threatens to drag the Italian nation further away from its previously controversial but unmistakably centrist and orthodox modern history.
A draft version that was leaked to the Italian press highlighted the potential coalition’s desire to force Italy out of the Euro – in fact, potentially, the European Union in general. The European project is widely recognised to have been around since 1951 with the creation of the European Coal and Steel Agreement. More recognisably, the signing of the Treaty of Rome in 1957 consolidated European solidarity and cooperation. However, the European Union only came about in 1992 with the Treaty of Maastricht; the agreement that also provided for the creation of the Euro.
The subsequently denounced draft coalition agreement spoke of the two parties’ mutual desire to deliver Italy back to a “pre-Maastricht setting” with a rediscovered “monetary sovereignty”. The desire is largely due to (the not entirely unfounded) blaming of the monetary union for the creation and perpetuation of a sovereign debt crisis and economic downturn that crippled Italy, providing unabating unemployment and meagre growth.
However, alongside the Maastricht treaty came the concept of European citizenship and the consequent free movement of people, a common foreign and security policy, not to mention judicial cooperation across borders. Responsible fiscal governance was also introduced alongside a banking and monetary stability mechanism. To return to a pre-Maastricht setting implies the denouncement of all of these mechanisms and values.
Of course, the United Kingdom is leaving the European Union, so what’s the problem? Well, as a principal premise, it would be nice to assume that the draft treaty of a potentially governing coalition of a developed European economic power would choose its words carefully, so one must assume that pre-Maastricht means pre-Maastricht. Therefore, it is not a hyperbolic extrapolation of the leaked document to assume that the potential coalition wishes to withdraw from all of the above.
Within such a case, Italy’s populist turn undeniably takes secession further than the United Kingdom’s exit. Even within the UK’s premature negotiations to date, concessions upon security and defence, the rule of European law and potential mutual recognition have already been made; all of which would be precluded by a pre-Maastricht setting.
The consequences for the Euro are immense. Already in the past few days since the announcement, the Euro has lost almost 1.5% against Sterling and closer to 2% against the US Dollar. The devaluation of the single currency is at least in considerable part due to the political and economic risk within the Euro. The immediate reaction within Italian treasury was a rise in bond yield on the ten year note in the order of ten basis points. Whilst risk is already heavily re-priced back into the Euro, there would remain considerable risk to the Euro from any contagion threats from an openly secessionist, populist, Italian government.
The threat to the Pound may also be significant. As has been visible from meetings of the European Council, and reportedly behind the closed doors of the supranational European Commission, a punitive persuasion is apparent. If it can be proved that member states are better off inside the Union than outside by using the United Kingdom as an example then member states and their populations will consider membership in their benefit, including a increasingly Eurosceptic Italian state. The increase in populist, secessionist, sentiment within the Union could exacerbate these tendencies, making the expected outcome from Brexit marginally worse. Understandably, therefore, there is also an increased risk to the Pound too from the potential Italian coalition. Overwhelmingly, the risk of contagion and break up within the Union and Euro is driving the currency lower.
Discussion and Analysis by Charles Porter