The presidential election is obscuring some noticeable improvement in Italy’s growth prospects, while Spain’s recovery lags. The ratings agencies are noticing.
Lauréline Renaud-Chatelain, Nadia Gharbi, Pictet Wealth Management.
Political noise remains an issue on the euro area’s southern periphery. While there are no general elections scheduled either in Spain or in Italy in 2022, the presidential election in Italy, scheduled to commence on 24 January, is receiving unusual attention. The outcome of the election is highly uncertain, but it could trigger considerable friction since one of the contenders is the current prime minister, Mario Draghi. While his election to the presidency may ensure institutional stability, it could also cause ructions within the fragile coalition that currently governs Italy.
Although the probability of snap elections, the worst-case scenario for markets, was pretty low at the time of writing, such an eventuality has started to be priced in by market participants, with the 10-year Italian sovereign bond spread vs. the Bund widening from a low of 98 bps (on 24 September last) to 132 bps (on 17 January). Early elections could push 10-year Italian spread further up towards 160 bps. They might even go higher, but we would not expect spreads to move above 200 bps.
The most likely scenario, in our view, is for the 10-year spread to tighten towards 110-120 bps by mid-year before moving up slightly towards 130-140 bps by the end of 2022, either because Draghi stays on as prime minister or because one of his senior ministers takes over, thereby ensuring reforms continue.
The second half of 2021 brought an unexpected upgrade of Italy’s sovereign rating by Fitch Ratings from BBB- to BBB and an upgrade to its ratings outlook from stable to positive by S&P Global. The structural reforms being undertaken by the Italian government in return for sizeable EU funds (as part of the Next Generation EU package) are seen as beneficial to Italy’s growth outlook, leading rating agencies to expect a faster reduction in its debt-to-GDP ratio. Ratings agencies could further upgrade Italy’s prospects this year.
By contrast, with Spain’s post-pandemic recovery lagging Italy’s, and with risks tilted to the downside. we do not exclude S&P Global downgrading Spain by one notch to A- in its upcoming spring review of the country’s sovereign rating.
