Italy: Fundamentals are the compass amid political twists

• A new Government: After three months of deadlock, 5Star Movement and the League agreed on a redesigned Government formation. Prof. Conte was again designated as Prime Minister. The “contract” between the two parties will be the “wish list” of the new government but uncertainty remains on how it will be executed and on implications for public finance targets.

• Economy: The macro-environment that Italy is facing is much more positive than the one during the Euro Sovereign Debt Crisis in 2011: In Q1 2018, Italy has enjoyed expansion for 15-quarters in a row. Overall, we still think that the economic fundamentals remain positive, yet we acknowledge that the current situation may significantly disturb business and consumer confidence. Overall, this is the key thing to watch to identify early signals in activity.

• Strengths and weaknesses: From the financial point of view, Italy’s main problem is the high level of government debt, although the high average maturity (6.8 years) somewhat protects it from a sudden transmission of higher interest rates into debt dynamics. Private sector debt is one of the lowest of the Eurozone. Household and corporate financial vulnerability would remain limited even in the case of a rise in interest rates. The Italian banking system soundness has increased: The share of NPLs (Non-Performing Loans) in banks’ balance sheets is declining progressively, especially for banks that have made large-scale disposals.

• Fixed Income: Going forward, the level of volatility will continue to be influenced by the news flow and will probably stay high until some crucial issues, especially in terms of fiscal budget, become clearer. We expect the ECB to stick to its mandate and agenda. Our central scenario is a progressive reduction of purchases for an end in December 2018. For the time being, we prefer to keep a cautious approach, and be very flexible (in duration and risk exposure) as conditions can rapidly evolve.It is too soon to step in, but we will clearly look for the right time over the course of the summer to enter the market.

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