Et Tu, Italy?

In this year of falling European political uncertainty, one of the Continent's largest economies was missing from the spotlight. Well, wonder no longer: Italy has joined the fray. Recent public comments from Matteo Renzi, former prime minister and current leader of the ruling Democratic Party (PD), have many experts thinking snap elections loom. Though just talk right now, even if Italy goes to an early vote, we believe the most probable outcome is further gridlock-a status quo that hasn't hindered the eurozone economy or markets.

Reports this week said Italy's four main political parties have agreed in principle on a new electoral system, giving rise to early election chatter. Renzi's center-left PD, the antiestablishment Five Star Movement (M5S), the center-right Forza Italia (led by one Silvio Berlusconi) and the far-right, anti-EU Northern League all agreed to pass a law by the first week of July that would replace Italy's current process with a German-style proportional representation electoral system. With this tentative deal in place, Renzi suggested Italy could aim to vote the same time as Germany's federal election in September, squashing any broad lingering European political uncertainty. But despite all the speculation, early elections aren't a given. Only President Sergio Mattarella has the authority to dissolve parliament and call elections, and he has indicated a preference to let current Prime Minister Paolo Gentiloni finish out his term to early next year, rather than rush into a vote-particularly with banking issues and the 2018 budget law still unresolved.

Some clarity on the Italian electoral law front is the primary reason early elections are even on the table. In January, the constitutional court ruled on the Italicum electoral law . Passed in 2015, the Italicum offered proportional representation for both the Senate (upper house) and Chamber of Deputies (lower house). However, parties needed only 3% of the vote to enter the lower house, giving smaller parties influence over legislation. The Italicum also awarded a supermajority (340 seats, or about 55%) to parties that won more than 40% of the vote in the lower house. The constitutional court kept most of the Italicum intact, save for a runoff vote component. After this ruling, Italy's four main parties have been in talks for a new electoral system, and German-style proportional representation is the current favorite.^[i] This system doesn't award the supermajority bonus and requires parties to win at least 5% of the votes to enter the lower house.

While making a German-style electoral system law is no given, Italy's current political landscape shows why the four biggest parties prefer it. For one, a 5% threshold virtually ensures power will be consolidated among the PD, M5S, Forza Italia and the Northern League. Current polling shows the PD and M5S running neck-and-neck at ~30% with Forza Italia and the Northern League around 12% each. Under the German system, these four parties would likely gain more votes-e.g., many smaller parties' votes could go to the PD-but current poll figures suggest no one party would rule alone: They would need to form a coalition. While a "grand coalition" between the more centrist PD and Forza Italia is in play through this German model, an anti-euro/anti-EU coalition between M5S and the Northern League is also feasible. M5S' strong poll numbers have stirred fears of greater political instability should they win power.

Though the prospect of an anti-euro/anti-EU coalition leading Italy sounds troublesome, political realities should temper some of those concerns. For one, M5S aren't automatically compatible with all populists, and they lack ideological ties with the other primary parties. (Even the far-right Northern League has served as a coalition partner with Berlusconi before as part of a broader conservative bloc.) Besides being "antiestablishment," it is difficult to pin down M5S' broader goals beyond holding a referendum on the euro-and party opinion on this issue is mixed, too. Even after M5S won 25% of the national vote in a 2013 general election, party leader (and former comedian) Beppe Grillo refused to ally with any mainstream parties, costing the group representatives. Moreover, M5S hasn't exactly been successful in its limited trials in power. For instance, Rome's high-profile M5S mayor has been hit with embarrassing corruption cases and cumbersome issues like mounting piles of trash. M5S has faced the same issues governing Italy as the rest of the establishment. A coalition between M5S and the Northern League-which share only some high-level similarities-doesn't necessarily mean big, streamlined action would be forthcoming. So even if the Germanic model is used for early elections-all hypothetical at this point-gridlock still looks likely to persist for the foreseeable future. This hasn't stopped the Italian economy from growing during the present expansion.

In our view, an Italian election-whether it happens later this year or in May 2018-would be another chapter in the broader theme of falling uncertainty in the eurozone. Despite the current angst over snap elections, holding them earlier would be akin to "ripping off the Band-Aid" and allow any uncertainty to clear up much sooner.^[ii] Rather than prolonged worrying for another year, investors would have the answers they're looking for, like: Is M5S leading the government or not? This would end the uncertainty, as just knowing an outcome brings relief. Moreover, even if M5S wins, it isn't an immediate "Italexit." Or, more poetically, a "Quitaly." Italy's constitution bans changing treaties through referendum, which is what M5S wants to hold. So while questions still remain, Italian snap elections aren't likely to bring about the type of change that will imperil the country's foreseeable prospects, let alone the broader eurozone's.