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Fund managers sound note of doom over Italy

Fund managers have reacted with concern to Italian political events. A hitherto obscure law professor has been appointed Italy’s new prime minister and there is speculation that the next economy minister could be economist and banker Paolo Savona, who has called Italy’s adoption of the euro a “historic error”.

Adrian Hilton, head of global rates and currency at Columbia Threadneedle Investments, warned that the developments “clearly present a risk” for Italian assets and also possibly for Europe but he said that the full extent of the damage would become clear only when the weak contract between left and right wing coalition allies was converted into policy.

Seema Shah, global investment strategist at Principal Global Investors, said “the worst-case scenario” for Italy’s inconclusive general election was unfolding, as the Five Star Movement and the Northern League – both anti-establishment parties – are on the verge of forming a coalition government.

“Although they sit on opposite sides of the political spectrum, they share two common ideologies: antipathy to the euro and a desire for aggressive fiscal stimulus,” she said.

Hilton forecast that should the new government move to fulfil its various fiscal promises – aggressive tax cuts, a dual-band flat tax system and a guaranteed income for the poor – then Italy was likely to endure a marked deterioration in its fiscal position which would court the wrath of both the eurozone authorities and the rating agencies.

Markets have also been unnerved by some of the coalition’s more unorthodox proposals, such as the cancellation of the Eurosystem’s quantitative easing holdings of Italian debt and the issuance of transferable short-term government liabilities, seen by some as a parallel currency, and have increased the premium they demand for holding Italian debt.

Charles St-Arnaud, senior investment strategist, Lombard Odier Investment Managers, said that while it was too early to have a clear view of how the situation would develop, it was time for investors to assess their exposure to European assets, especially Italy and the rest of the periphery.

“Investors need to be ready for the possibility of a further increase in Italian bond yields, widening of spreads and equity market underperformance in Europe, given the high level of uncertainty that is likely to persist in the absence of changes in government policy”.

But Anthony Rayner, manager of Miton’s multi-asset fund range, said European political risk was nothing new and that recent price action amongst Italian assets was reflective of an unusual coalition.

He said: “It also seems to reflect more demanding investors, indeed, and it feels like the bond vigilantes might be back in town.”

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