While major share markets rebounded last week, Europe is still suffering the ongoing weakness in Italian shares.
Italy is the fourth-largest economy in the European region after Germany, the UK and France. Its new government is an alliance between populist parties the Five Star Movement and the Lega (League).
“Italy clearly remains an issue,” AMP Capital chief economist Shane Oliver said. “Sure, an early election has been averted, but the new government’s proposed 6 per cent of GDP fiscal easing leaves it on a collision course with the European Commission and arguably with bond markets.
“It will take a while, but the problem will likely come to a head on 20 September when the government will present its budget for evaluation.
“Anticipating this, Italian bond yields have shot up again and this will weigh on Italian shares and the Euro given the risk that conflict over the budget could morph into talk of an Itexit.”
However, given the difficulties involved in leaving the Euro and popular support for it (ranging from 57 per cent to 72 per cent depending on the opinion poll), Mr Oliver believes that, ultimately, Italy will likely stay in, and so a fiscal compromise will be reached.
“On this front, two things are worth noting,” Mr Oliver said. “Firstly, the European Commission will probably provide Italy with a bit of leeway.
“Secondly, German chancellor Merkel is starting to lend support to some of French President Macron’s proposals for strengthening the Eurozone. This could form part of a broader compromise with Italy.”