Italian Election Produces Stalemate
March Market Overview
The anti establishment parties made sweeping gains in the Italian general election and looked set to shape a large part of the government, albeit this will be in the form of a coalition. Markets saw a bout of volatility as central banks, in particular the Federal Reserve, predicted monetary policy could be tightened quicker than expected due to higher inflation expectations and the strength of the US economy.
In December last year, the Italian president, Sergio Mattarella, dissolved parliament which gave way for a snap election called for 4th March 2018. This was the first vote based on the new electoral system (Rosatellum) that was ratified last year. Italian politicians demanded this new system mainly to increase the probability of one party achieving a majority of parliamentary seats. Despite this, the result has, once again, produced a political deadlock with no party achieving a clear majority. The final vote resulted in a hung parliament and a period of tense negotiations lead by Sergio Mattarella to begin the foundations of a new government.
The Five Star Movement, which was created in 2009 by the comedian Beppe Grillo and is now led by Luigi Di Maio, a young Neapolitan, appear to have been the winners of this election and their channelling of the strong discontent with the establishment seems to have been successful. They will not be able to form a government unless they strike an alliance with other opposition parties but there is now no doubt that they are a dominant force in Italian politics. However, it must be taken into account that Italy is well known for their coalition governments which have now spanned over a fifty year period. The comforting thought is that this historic political uncertainty has not hindered confidence or economic activity in other European countries - most notably in Germany and Spain. The coalition negotiations are likely to be protracted affair which could span over several months. A fresh election for a more certain result also cannot be ruled out.
The US economy grew at a 3% in the last quarter of 2017 and it is about to receive additional stimulus from tax cuts and higher federal spending approved by Congress. Jay Powell, the new Federal Reserve Chair, is now presented with a dilemma as he attempts to prevent an economy with unemployment at its lowest rate since the early 2000s from overheating even as inflation hovers below the Fed’s target. The Federal Reserve is predicted to hike rates at their next meeting, having kept them level in January at Janet Yellen’s final meeting as Fed Chair. The central bank’s previous forecast, in December last year, predicted three interest rate rises in 2018 alongside continued reductions in the size of the central bank’s multitrillion-dollar balance sheet. However, many economic analysts now believe that Federal Reserve is increasingly likely to lift rates four times this year as unemployment continues to drop and inflation edges back to 2%.
With the positive economic growth rates evident across major economies this is allowing central banks in the United States, Europe and elsewhere to begin tightening some of the monetary policy endorsed immediately after the global financial crisis. The growing economies have led to fuller labour markets which could push up salaries. Rising wages could result in higher inflation and, in turn, a faster pace of short-term interest rate increases by central banks. This retreat of monetary policy by central banks led some investors to begin profit taking as they believed companies could not sustain without the cheap and easy money they could obtain from central banks. However, the positives of a more stringent monetary policy from central banks is that it demonstrates that economies are growing and this is positive for the earnings growth of corporations.
Brexit & the UK
The latest twist in the Brexit negotiations is Jeremy Corbyn’s commitment to a customs union with the European Union. The Labour Leader used a keynote speech on Brexit to confirm his party’s position and offer a clear alternative on the issue of the customs union. This has caused friction within the Conservative Party who believe that this change of stance from Labour is an obvious attempt to force a vote of no confidence and therefore impose an earlier general election on the UK. Pro-European Conservative MP’s have already stated they would join with Labour to urge Theresa May to alter her vision for Brexit. This could potentially weaken the government’s negotiating position ahead of further talks with Brussels.
Senior diplomats with the European Union have stated that they would be “willing to discuss” a customs union deal where Britain would apply the same external tariff as the EU. This would permit more fluent trade within Europe but it could limit the UK from making trade deals with other nations. Eurosceptics have argued that this would not be honouring the referendum result and is therefore a betrayal against the democratic vote. The negotiations will continue with the EU summit. This is where the transition phase will be decided, the divorce bill legally drawn up and Michel Barnier, the European Union negotiator, may be given a mandate to negotiate the EU’s future relationship with Britain.
The European Central Bank (ECB) decided to keep interest rates at record lows and restated their commitment to keep monetary stimulus in place and potentially expand quantitative easing if it is necessary whilst inflation continues to stay below target. The ECB’s governing council repeated that it expects interest rates to remain at present levels until the end of its quantitative easing programme and they will continue with the purchase of €30bn of bonds each month. Policymakers have stated that this could be potentially increased until indicators see more signs that the inflation target will reach 2%. The central bank have scheduled the end of the quantitative easing programme for the end of September 2018. However, policymakers have indicated this could be extended depending on economic indicators/forecasts closer to the time.
The central bank have been comforted by Eurozone growth reaching its highest level in a decade. The Eurozone surpassed the US and UK, growing by 0.6% in the third and fourth quarter of last year. The annual growth rate for 2017 was 2.5%, the highest level reached in ten years and up from 1.8% in 2016. The US expanded by 2.3% and UK by 1.8% last year. The political stability of Europe last year helped to provide confidence to companies and investors. The win for Emmanuel Macron in France’s presidential and parliamentary elections was a typical example of this. French gross domestic product rose 1.9% in 2017, the fastest since 2011. Capital spending is widely seen as indicator of investment confidence and this rose to 3.7% up 1% from the figures produced in 2016. These positive figures has given optimism to global growth and economic sentiment across Europe.
China have announced that they are set to end their two term limit on presidencies for Xi Jinping in a move that would pave the way for Chinese President to remain in office beyond 2023. Analysts have argued that this will allow political continuity to allow the Chinese Premier to follow through the with his economic reforms. This is positive in terms of political stability, but it still remains to be seen whether China can be successful in their aim to reform their economy.
In Japan, Haruhiko Kuroda was confirmed as the Bank of Japan’s (BoJ) Governor for a further five years. Lifting inflation still remains slow and Kuroda reaffirmed the need for ‘powerful monetary easing’ when he spoke in front of Parliament in February. It seems likely that the BoJ will keep its 0% yield target for ten-year government bonds in place in the near term. Monetary stimulus has succeeded in boosting the Japanese economy and pushing up the employment rate.
Interest rate rises and the tightening of monetary policy suggests that the global economy is healthier. Trump has now managed to push through his tax reforms and this is likely to be beneficial for US corporations.
The Italian election has, as expected, produced an unclear result and therefore a coalition government is likely to be achieved.
The ongoing Brexit negotiations will continually be at the forefront of investor’s minds until a trade deal has been granted.
As at 5th March 2018
Please note: The opinions expressed in this update are those of A&J Wealth Management Limited only, as at the date stated above, and are subject to change. The update is for information purposes only.
Source: Financial Times