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Italian election puts political risk back on the table – money managers

A strong turnout for populist parties in Italy's general election brings political risk back to the forefront in Europe, warn money managers.

Italians went to the polls Sunday, with results showing a stronger than expected support for the Five Star Movement, M5S. The country's center-right coalition did not gain enough votes to form a government, resulting in a hung parliament.

The democratic party also suffered a "poor result," said Claudio Ferrarese, portfolio manager at Fidelity International, in a comment, although this was in line with expectation. He added that anti-establishment party M5S was expected to gain around 28% of the vote, but took more than 30% in a "stronger than expected" result.

The Stoxx Europe 600 index was up 1.22% on Monday, while the Italian government bonds index fell 0.14% in dollar terms.

"After 2017 ultimately proved benign for eurozone political risk, the unexpected strong performance of the Five Star Movement brings these threats very much back to the forefront," said Timothy Graf, head of macro strategy for Europe, Middle East and Africa at State Street Global Markets, in a separate comment. "Though M5S officials have toned down anti-euro rhetoric in recent months, the euroskepticism within the bloc could ultimately reintroduce the existential threat to eurozone stability long thought diminished. Forming a government has many challenges, but this result could dent the strong consensus support the euro currently enjoys," he warned.

While the result of the election looks "messy," the chances of Italy leaving the eurozone have not materially increased, said Adrian Hilton, head of global rates and currency at Columbia Threadneedle Investments, in a comment.

He said the future Italian Parliament will likely feature one anti-establishment party, but warned a coalition comprising both parties in this category — Lega and M5S — "would probably worsen relations with the European Commission, especially around fiscal targets," added Mr. Hilton.

In a separate comment, Azad Zangana, senior European economist at Schroders, said the result is "very important for international investors, especially given the size of the Italian economy."

He said despite a good turnout for euroskeptic parties, "exit from the euro and EU are low risk … because Italy's constitution does not allow for such a vote, and a change in the constitution would require a two-thirds majority, which left and right wing euroskeptic parties do not command."

The bigger risk, he warned, is "fiscal slippage, and possibly the rolling back of important reforms from recent years. This would put Italy on a collision course with the European Commission, and may even awaken the dormant bond vigilantes."

International investors may react to a government led by "extremist parties" by dumping Italian government bonds, "causing yields to rise sharply on its huge mountain of government debt worth around €2.2 trillion ($2.7 trillion) or 133% of GDP at the end of 2017." The European Central Bank's asset purchase program, however, is likely to keep markets calm, said Mr. Zangana, although he also noted that the expected end of quantitative easing later this year would make Italy more vulnerable.