The business cycle

A Changing Europe Monitor: Flash note

By January 25, 2018 April 25th, 2018 No Comments

President of the Republic Giorgio Mattarella has called elections for 4 March, so it is time to look at the potential impact of the next government’s strategy on the economy and financial markets in the short (12-18m) and long term (24m+).
We see three realistic scenarios: a centre-right coalition victory; a coalition government led by M5; and a surprise victory by PD, with an even more surprising coalition government led by them. In our view, the scenario where no party manages to form a government is, in practice, very low probability and, should elections be called again, we would end up with the same three scenarios anyway.
We assess the divergence in real GDP growth likely in 2019E, which is the first time the incoming government would be reasonably able to influence the economic recovery, between the various scenarios of c.1.4ppts, with a high of 3% growth should the centreright coalition win, and 1.6% should M5 lead the next government. In all scenarios, the economy is likely to continue to grow above its potential rate thanks to the favourable global backdrop and an increased fiscal stimulus.
In our view, the budget deficit will be widest under a centre-right coalition, and narrowest if PD leads the next government; however, in all cases, the debt to GDP ratio will drop further thanks to the positive impact of recovering inflation and growth in the next two years. The unemployment rate is also likely to continue to drop, albeit less so if M5 is in power.
At this stage, we do not see enough evidence to say with confidence that any of these government scenarios will lead to a material rise of potential growth over a horizon of five years, as none, in our view, seems sufficiently well-positioned to reverse the capital outflow and brain drain the economy is experiencing currently.
Our projections may seem at odds with the occasional warnings seen in the press that an M5-led government would lead to instability due to its lack of experience in government at the national level. On the basis of what other countries have experienced in similar conditions, a lack of experience usually leads to greater policy noise in the first year of a term and slower policy implementation at least initially, but also greater fiscal prudence relative to the election promises. These factors are likely to weigh on asset prices and the private sector’s propensity to invest, but are not enough to fully offset the strong pull from the global recovery and the ECB’s quantitative easing support.
EU(ro) scepticism is alive and well, and these elections, in our view, are likely to have a material impact on the future of the EU. However, this influence will not be evident in the short term, and thus likely to be ignored by the financial markets. That said, companies and families would do well to think about what would happen if the Euro fails. #ChangingEurope

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