An Italian "Hung Parliament" - Europe's Biggest Political Risk

As was reported in the latest Tecne poll for Italy's SkyTG24 released a few hours ago, support for Italian frontrunner Bersani's coalition has dropped once more, declining by 0.8% to 33.2% in the week ended February 7, while the ratings of the bloc headed by Italy's former prime minister Silvio Berlusconi keep rising on momentum generated by Monte Paschi scandal, boosting his popularity to 29.2%, or +1%, and now entirely within the margin of error.

At the same time outgoing PM Monti has seen yet another drop in popularity, now down 1% to 12.9% while ex-comedian Beppe Grillo's support keeps rising, and is now at 16.3% up 0.8%. Combining all this data means that with three weeks to go until Italy's February 24-25th election, courtesy of the seemingly improbable surge in Berlusconi's popularity in recent weeks, the biggest emerging risk for Europe in the coming month is that of an Italian "Hung Parliament" which would then likely result in another round of elections in a matter of months, jeopardizing the Italian "success story" and pushing headline political risk once again into the open.

As Bank of America explains it all depends on whether the Centre-left coalition together with Monti can secure the 158 votes needed to avoid a Hung Senate, as failure to do so could lead to the worst possible outcome - yet another round of elections in a few short months, and with it, far more political more uncertainty, which added with the wild card that is Rajoy disintgerating popularity in Spain, will mean a rekindling of the European house of cards fire, and yet another round of bailouts and stabilization programs by the world's central banks which are already massively stretched just to keep the US stock market rising in its blow off top phase.

Bank of America explains:

The current opinion polls are consistent with a majority in the Chamber of the PDSEL coalition and a majority in the Senate for a cooperation between PD-SEL and the Monti coalition. According to the election rules, the coalition that wins the relative majority will automatically be given 55% of the seats in the Chamber. In the Senate, the same principle applies, but to each region. In addition, two key thresholds are de facto the most important: 20% for coalitions (that is the centre left coalition dominated by PD+SEL, and the centre right coalition driven by PDL+Northern League), 8% for lists not in a coalition (Monti).

Predicting the Senate outcome for pollsters is particularly challenging since it depends on the performance of each major player in each region and depends on the turnout. Plus, this is the first race where more than two major parties participate, so even small swings in the results Monti’s list and Five Stars could make a meaningful difference to the overall result.

Centre-left plus Monti would secure a majority in the Senate as of today

Based on opinion polls, PD-SEL-Monti securing a majority in the Senate: with 2 seats to spare if PD loses the three key regions and with 14 if they win Lombardy. Table 1 below shows seats distribution based on current opinion polls, assuming PD-SEL lose Sicily, Veneto and Lombardy, and that the election result is broadly in line with the latest detailed survey available from Tecne’ conducted on the 31st of January showing 34% for the centre-left coalition, 28.6% for Berlusconi, 13.3% for Monti and 16% for Five-Stars. We highlight that the opinion polls show Sicily and Lombardy is still too close to call, in the event that PD manages to secure Lombardy, the majority in the Senate together with Monti would be 14 seats.

At this juncture in the election campaign, all parties aim to differentiate themselves and therefore are not open to any cooperation post election. However, given the policy programmes and past experience, a cooperation between the centre-left and Monti as highly viable, according to political commentators.

The Senate may end up hung if either Berlusconi gains popularity, PD loses further support or Monti loses approval rating. If the centre-left coalition fails to secure at least 158 seats together with Monti then either another grand  coalition would surface or elections may be called again in a matter of months. A grand coalition would de facto involve the same political forces as in 2012: PDL, PD and centre parties.

What can be done with a left-led coalition and a grand one

We believe a PD-SEL-Monti cooperation can deliver improvements in most areas on our “wish list”, which would therefore be bullish for market sentiment and growth potential. A grand coalition involving Berlusconi’s party in our view would support public spending cuts, probably a reduction in energy costs, further services liberalisation and upgrading IT infrastructure. Cooperation on all the other issues in our view will be highly challenging and even an agreement on public spending cuts will be slow as the two political sides disagree on how to implement the cuts. This in our view should be enough to prevent the debt to GDP from spiralling out of control in the near term, but will be insufficiently forceful in many areas of required institutional change and therefore the risks surrounding the long term growth potential will remain.

In our view, the worst case scenario is that of early elections months after the February polls as this would imply that no cooperation between political parties is viable and there will be several months of uncertainty on whether voters’ preferences would shift, if at all.