Italy: Challenges ahead, no debt crisis seen at the moment - Danske Bank

Analysts from Danske Bank, took a look into the significants challenges ahead for Italy. According to them, Italy is unlikely to rock the Euro much this year but they warn that a debt/political crisis would have an impact. 

Key Quotes: 

“Italy is frequently mentioned as the potential biggest risk factor in the euro area. Despite this, Italy is trading at the tightest spread versus Germany YtD. In our view, there are obvious risks looming in the pipeline for Italy.”

“The Italian banking system is suffering from a high share of NPLs and weak capitalisation. Although the Italian government has started to address the problem and there has been progress in the case of Monte dei Paschi and the Veneto banks recently, a thorough overhaul of the banking system as a whole is still needed.”

“Problems in the Italian banking system and government bailouts are a particular concern due to Italy’s already high public debt burden. Although the fundamental weakness in Italy is currently not priced, concerns about debt sustainability could resurface and bond yields rise, once the ECB shifts towards policy normalisation and/or
political risks return to focus. The muted growth outlook further aggravates the precarious public debt situation.”

“Political risks further add to Italy’s debt and growth challenges. Although early elections look increasingly unlikely now, there is a risk that the euro-sceptic Five Star Movement could come to power after the next general election, due to take place by May 2018 at the latest. However, even with a Five Star government, an actual ‘Italexit’ seems unlikely given that the process would be long and cumbersome and public support for the euro has recently increased.”

“Given the size of Italy’s economy and government bond market, regional and global spill overs from a potential debt crisis would be significant. The limited scope of rescue funds available for Italy should a debt crisis actually erupt makes Italy a key risk to general market sentiment and the development and sentiment towards the above-mentioned risks crucial to follow in detail.”

“The relief in EUR crosses seen following the Emmanuel Macron win in the French presidential election this year illustrates the sensitivity of the cross to election risks. Thus, on the one hand, one may argue that the euro has become too complacent regarding political risks lately and, on the other, one may argue that the eurozone has become more robust to such issues.”

“In our base case of limited Italian tensions, we see the election in Italy playing only a minor role for EUR crosses throughout our forecast horizon: it would merely have the potential to limit the appreciation pace for EUR crosses heading into 2018. We still look for EUR/USD to edge towards 1.22 in 12M in this case.”