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Equity

EU must tread carefully with Italy

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The sell-off in Italy’s equity and debt markets in the lead-up to the creation of a new Italian government shows that investors are nervy about the euroscepticism of its new law makers, but Europe also has a part to play in ensuring that markets don't end up in straits such as the sovereign debt crisis of 2009-12.

BTP yields rose again on Tuesday as the new Italian prime minister, Giuseppe Conte, laid out an agenda for “radical change”.

The FTSE MIB also fell thanks to Conte’s speech, trading almost 1% down on Monday’s close as of Tuesday afternoon.

European stock indices, in general, have been somewhat immune to Italy and it is too early to talk of contagion. But, there were indications last week that US investors were starting to go cold on European assets as a whole because of the problems in Italy.

Equity bankers were also nervous that hostility between the EU and Italy could stop funds from committing capital across all European IPOs, something which has already been the case in Italian deals, because of fears over another eurozone crisis.

Europe has won investor confidence through painstaking reforms since its last crisis. As such the continent’s stock of bad loans has been reduced, its corporations are more profitable and its banks are now better capitalised.

The EU has worked hard to win back global support for the eurozone and it should not deliberately heighten tensions with the Five Star/League coalition if it can avoid doing so.

Any policy that threatens the core nature of the economic bloc should of course be challenged, but the EU has to pick its battles carefully.

The new government, which is by its nature eurosceptic, is likely to challenge the EU on a multitude of issues.

If the EU takes an overtly hostile approach to Italy on every policy being proposed by the new government, then investors will likely plan for a repeat of the eurozone crisis, remembering how harsh the union was with Greece in the early days of the first crisis.

But if it takes a more conciliatory view, and portrays an openness to dialogue, then confidence in Europe, and Italy, can be maintained.

One senior European banker speaking last week said that he hoped the EU would take on board the victory of the Italian populists and perhaps take it as evidence that it needs reform.

He added that EU openness to change would likely be welcomed by many politicians across the continent and might even aide the future relationship between the EU and the UK after Brexit.

And importantly, if the EU is willing to modify positions on which it previously seemed unmovable, such as loosening eurozone budgetary restrictions, then investors will likely forget fears of an imminent crisis on the continent.

But, if it acts in the same manner as it did following political upheaval in Greece, than many fund managers will begin to see another crisis as inevitable, with ramifications which are potentially far worse than what was seen in 2010.

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