Italy's election offers many risks but 'little chance of Italexit'

Italy's election early next month is unlikely to result in an 'Italexit' from the European Union, said Berenberg on Thursday, but is likely to see former leader Silvio Berlusconi emerge as a kingmaker and could still result in the country holding referendum on its membership of the euro and reverse recent labour reforms.

The Italian election on 4 March has long been cited as one of the key political risks for Europe this year, with worst case scenarios for the market being a coalition consisting of the anti-establishment Five Star Movement (M5S) together with other radical parties that could perhaps push for an EU exit.

Berenberg's Carsten Hesse said a reversal of Italy's recent labour market and pension reforms is one of the "major risk" and also cited a 10% risk of new elections and 5% likelihood that M5S will work with centrist parties.

"Most of the parties are promising to reverse structural reforms and increase spending significantly. Some are even threatening a referendum on Italy’s membership of the euro – although since Le Pen’s defeat in the French elections, most politicians have toned down their anti-euro rhetoric."

This scenario looks unlikely, Hesse said, giving it a 5% probability and pointing to polls suggesting none of the parties of the centre-right/right-wing and the centre-left alliance will achieve a majority, with former PM Berlusconi seen as a likely kingmaker after the election.

"We therefore expect that the next government will be formed of a grand coalition (70% probability), including parties of the centre-left and centre-right/right-wing. This should enable Italy to continue on its current path of modest economic growth and manageable fiscal deficits."

Finally, Hesse played down the change of systemic risk for the wider EU: "We do not expect a euro exit by Italy, or a systemic crisis that could endanger the eurozone economy."