[UPDATED] ANALYSIS: Italian PM Draghi updates the Senate on Wednesday, July 20th; a new coalition or snap elections becomes increasingly likely

Analysis details (07:30)

• 
  Summary:On Wednesday, Draghi will provide an update to the Senate, after which a formal confidence vote will occur. The indicative timeline is for around five hours of debate in the morning from circa. 08:30BST/03:30ET followed by an afternoon/early-evening confidence vote, which will likely show confidence in Draghi’s coalition given the size of its majority, even if M5S abstains. Following this, Draghi will speak to the Chamber of Deputies on Thursday (the other house of the bicameral parliament, which undertakes identical functions but does so separately). While Draghi has already attempted to resign, President Mattarella blocked this and deferred him to the Wednesday update; Bloomberg reports indicate that Draghi still intends to step down. Assuming this occurs, then the options would be a new coalition and PM or snap elections – in the latter scenario, it is possible Draghi will serve as a caretaker in the interim. If Draghi does not resign, then a rejigged coalition without the Five Star Movement is an option; however, Draghi has previously ruled this out. Out of these possibilities, a continuation of the coalition or a reshuffle with Draghi remaining are the least disruptive and could see a narrowing of the BTP-Bund spread (currently circa. 225bp). Conversely, snap elections would be the most disruptive and therefore see a widening. Note, the ECB meets this week and on Thursday it may announce fresh details about its Transmission Protection Mechanism (TPM).


• 
  Recent Developments: On Tuesday, July 19th Draghi held a meeting with the centre-right coalition which, ANSA writes, “ended with glimmers of hope” as Democratic Party leader Letta said there are conditions which will allow tomorrow [Wednesday] to be overcome. Members of the 5SM have expressed a desire to vote in favour of the government, despite their prior stance on the cost-of-living package; note, this would be relatively in-line with their initial stance and it will be crucial to see if they are willing to remain in the coalition or not in terms of whether Draghi remains or resigns.


• 
  Last Week: A vote was held in the Senate on July 14th in relation to the cost-of-living crisis, the 5-Star Movement (M5S) abstained from this announcing that while they retained confidence in Draghi’s government, they could not support the package. Despite M5S’ actions, the motion passed due to the 175/321 ex-M5S majority the coalition holds within the Senate. Subsequently, PM Draghi went to Italian President Mattarella and after lengthy discussions offered his resignation, which Mattarella refused to accept and instead asked Draghi to return to the Senate this Wednesday (July 20th) to provide an update. On the coalition, Salvini’s League made it clear that they were not willing to remain within the government under the scenario that M5S quits, and given they hold 60 senate seats, this would erase the ex-M5S Senate majority.

Potential Outcomes:

• 
  Existing coalition, led by Draghi: Following M5S boycotting of the confidence vote, leader Conte sent a list of demands to Draghi which included things such as a minimum wage and guarantees for their desired policies such as welfare payments and green home incentives. However, the stance outlined by the Centre-Right coalition leaders (who are involved in the gov’t coalition) makes a return to the status-quo challenging, as League’s Salvini and Forza’s Berlusconi said they would not now support a coalition with M5S. Their removal would erase the current coalition’s Senate majority, and thus likely lead to the coalition losing the confidence bill – if M5S re-joined.


• 
  New coalition, led by Draghi: PM Draghi could ask President Mattarella to allow him to attempt to form a new government without the 5-Star party; as this would allow the 5-Star to stick to its principles without collapsing the government that it retains overall confidence in (opposing just the crisis package), and for Draghi to enhance his credibility within the political sphere. Such an option is possible as assuming the government ex-M5S remains intact, then they will control 175/321 Senate seats and thus retain a majority. However, the aforementioned stance of the League muddies this path; although over the weekend Salvini and Forza Italia’s Berlusconi stated they are now not willing to remain in a coalition with M5S, due to their incompetence. While conflicting with Salvini’s initial stance, this perhaps increases the likelihood of the current coalition ex-M5S remaining in control with a smaller, but still effective, Senate majority; a majority that, if Conte’s weekend remarks are indicative, would still retain the support of M5S as an external party. Note, the retention of Draghi as PM here is clouded by him previously stating he would not continue at the helm without M5S. Moreover, recent reports note some 5-Star deputies are ready to split with leader and back PM Draghi.


• 
  New coalition, Draghi resigns: Given the above complications, Draghi may decide to remove himself from the situation (as he attempted to do last week) and allow the parties to come to an agreement without him. Under this scenario, the most likely coalition would be the current one without M5S (61 Senate seats) given the stance outlined by Salvini’s League (60 Senate seats) and Berlusconi’s Forza Italia (51 Senate seats, given the grouping with UDC). Without M5S, the coalition would be 14 seats clear of a majority in the Senate, so the support of essentially all members is essential. If a new coalition can be agreed upon, then the appointment of another unity-style PM is possible as the government’s short-term focus will be the cost-of-living crisis and elections are already scheduled for H1-2023, ING highlights that Finance Minister Franco is a plausible option.


• 
  Early/snap elections: Currently, Italy is scheduled to hold its next general election no later than June 1st 2023; reminder, at this election, the size of the Chamber of Deputies and Senate will be reduced to 400 (prev. 630) and 200 (prev. 322) respectively. As a guide, Democrat Leader Letta said elections could be held as soon as September 25th (ANSA, for instance, also highlights October 2nd), while he hasn’t provided commentary on the scenario, it is possible Draghi would agree to remain in place as a caretaker for the summer. The most recent opinion poll, via Tecne on July 16th, didn’t show much change from the prior update (July 8th) with Brothers of Italy (FdI) topping the pile on 23.2% followed by the Democratic Party (PD) on 23%. Such a result, if polls are indicative, would mark a significant changing of the political landscape vs 2018, where the dominant party was M5S with 32.7% of the Deputies Chamber vs 9.7% (-23pp) under current polling. Amidst this, the Centre-Right coalition stands to benefit the most and would likely secure power, as while the League (-2.9pp) and Forza (-3.7pp) have been fairly steady, Brothers of Italy (+18.8pp) has seen a significant surge in support at the expense of M5S (-23pp).

ECB/Market Implications: 

• On Thursday we await details of the ECB’s TPM from the latest policy meeting (where a 25bp hike is expected), the newsquawk preview is available here. The TPM is intended to combat an unwarranted widening of spreads between core and periphery nations, due to the implications for policy transmission and funding costs, for instance. Amidst the ongoing Italian turmoil, the challenge for the ECB is outlining, not to mention potentially using, the new mechanism. A challenge that will centre on determining what is and is not an unwarranted widening of spreads. Recently, ECB’s Rehn (interestingly during the ‘quiet period’) said we could see a difficult period in Italy, which could be the first political victim of the energy crisis. Furthermore, outspoken hawk Nagel has made clear that he believes the tool should only be utilized in exceptional circumstances and requires narrowly defined conditions and duration. Although dated, as a guide, the ECB’s Italian representative Visco said a BTP-Bund spread of sub-150bp would be justified, while a spread over 200bp is not. ING writes that under all possible scenarios, though less so if Draghi remains PM, the recent turmoil has brought elections closer and thus makes tightening to sub-185bp challenging, as it will be difficult for the ECB to justify BTP purchases without a stable domestic situation. Specifically, highlighting the potential for a 260bp BTP-Bund spread under early elections.

20 Jul 2022 - 07:30- Fixed IncomeEconomic Commentary- Source: Newsquawk