The twists and turns of Italian politics have concentrated investors’ attention on the virtues and vices of Italy’s future fiscal path. We believe that focusing only on this issue means that two far bigger topics that are necessarily intertwined fall out of sight: the future of the European Union and the negotiations on the EU budget that are taking place, and the prospects for the Eurozone monetary stance. Italian politics, in our view, must be analysed with these two big themes in mind, as boosting Italy’s growth and changing the structure of the European Union are the two topics at the core of the most popular parties: the 5 Star Movement and the (Northern) League.
Every seven years, the European Union presents its Multiannual Financial Framework, known as the EU Budget. The European Commission presents its proposal, currently the outlook for 2021-2027, and the budget is approved by the European parliament and the council. The budget under discussion is “special” – in a historical context – for at least three reasons: it will be the first one without the UK as a member state, it is trying to put forward the implementation of a common corporate tax base (something discussed since the 1960s!), and it is aiming to be approved before the 2019 EU parliamentary elections, which is seen as the critical test to assess whether the “wave of populism” that is engulfing Europe is coming to an end.
In this context, the agreement between M5 and the Northern League calls for advancing several important changes aimed at loosening the fiscal parameters imposed on all member states and the disbursements of the EU funds.
The stance of the ECB or the role of monetary policy are, of course, not part of these negotiations, but the future of monetary policy is inevitably affected by these negotiations for two key reasons: they will either bring the Union closer together, or they will fuel the economic and political fragmentations that exist and should not be ignored. Secondly, it appears to us that European politics has often responded to existential risks with more money and this time is no different, so it will likely require ongoing monetary support in the coming decade.
At the time of writing, Italian President Sergio Mattarella has given a mandate to former IMF economist Carlo Cottarelli to lead a caretaker government until another round of elections, or a new coalition emerges in favour of his government. Cottarelli, however, has virtually no political backing and, thus, early elections may be triggered in July. Regardless of the timing of the next elections, in our view, there is no viable way to change the 2019 budget materially, which could be seen as a reduction of policy risk in the near term. However, in our view, this option actually increases the policy risks in the long run and, if anything, it is likely to fuel Euroscepticism in the coming years.
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