In just a few days, investors have shifted from perhaps excessive complacency to excess pessimism about Italian politics.
Volatility is likely to remain for some time, as Italy is entering into unknown territory in terms of governance, which is perhaps worth a specific political risk premium. However, even if a serious confrontation is inevitable between the new government and the European institutions (on immigration, fiscal policy and foreign policy), we do not expect an imminent default risk or euro exit. Weaknesses in the Italian economy are well identified (public debt, very low potential growth, low productivity), but the economic situation has improved significantly in recent years. As long as monetary and financial conditions remain accommodative, the recovery in Italy should continue.
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