Another political crisis in Italy?

• Alive Italy party left Italian governing coalition

• Snap elections worst possible scenario but very unlikely

• Muted market reaction

The past two years have been very intense in the Italian politics. Parliamentary elections in March 2018 showed strong support for populist League and Five Star Movement parties. However, as both won almost equal support, neither was willing to allow the other one to rule. However, after 2 months of negotiations, non-partisan Giuseppe Conte was proposed to become the Prime Minister and two aforementioned parties have forged a coalition.

Nevertheless, Matteo Salvini, leader of the League, started to emerge as a central figure in the Italian politics and the coalition ultimately collapsed. As League's support was growing, calling snap elections risked diminishing Five Star's role on the domestic political scene and the populist party forged an alliance with centrist Democratic Party. However, now it looks like this coalition may be falling apart as well.

The Italy Aive, led by former prime minister Matteo Renzi, has decided to leave the coalition earlier this week. While Italy Alive is a small party, the governing coalition relies on it to hold a majority. Nevertheless, Renzi does not rule out continuation of work with current coalition members and talks are expected to be held on what to do next. What is the purpose of the move then? Renzi has been at odds with Prime Minister Conte since they began working together and leaving the coalition may be just an attempt to make reshuffles in the government, including getting rid of Conte.

It looks like what we are observing is just pure politics with Renzi trying to increase his influence over Italian political scene. The most likely option is that coalition members will find a way to continue forward, probably with a new Conte-led government. The worst possible scenario would be calling snap elections as it would greatly increase uncertainty. However, it does not look like a likely option as current governing parties, including Renzi's Italy Alive, could lose control at the expense of Salvini's League.

Market reaction to these events have been muted so far with Italian-German yield spread widening slightly. This hints that markets assume that the current governing coalition will prevail and Italy's political and economic agenda will remain more or less unchanged. However, if snap elections are called, some risk-off moves could be spotted in Europe. According to recent polls, League and Forza Italia have a combined support of over 40%. Should they win, one of Europe's hardest pandemic-hit countries would be led by eurosceptics and may turn onto a collision course with the European Union.

So far, market reaction to recent developments in Italy has been limited. EURUSD has pulled back this week but the move can be mostly ascribed to broad USD strength. Ongoing break below the support zone at 1.2140 can be worrying but unless we see a break below the lower limit of the Overbalance structure at 1.2070, bull case shall remain intact. Source: xStation5