Home / Opinion / Columns /  Why markets are spooked less by Rome’s turn than London’s

The dust is settling on the poll victory of Giorgia Meloni, poised to lead Italy’s most right-wing government since Mussolini, as part of a coalition that opponents say is a gift to Vladimir Putin. Yet, it’s the UK’s ‘Trussonomics’ that has triggered the bigger selloff in financial markets, which is a revealing indicator of where today’s economic radicals sit.

While Meloni’s euroscepticism and closeness to Hungary’s strongman Viktor Orban have some European leaders on edge, she is seen sticking with predecessor Mario Draghi’s stance on supporting Ukraine and budget commitments. The tango of coalition politics and constraints of EU fiscal rules have kept investors from panicking over an economic platform that includes tax cuts and a bridge to Sicily— despite a potential cost of up to 3.9% of GDP.

The spread between Italian and German government bond yields—known in Italy as ‘lo spread’—has widened but remains narrower than when the pandemic struck, or when populists last came to power in 2018 and promised to fight bond-market speculators. Meloni is expected to favour culture wars over economic ones.

Contrast that with the reaction to tax cuts and reforms costing £161 billion, or about 6.5% of GDP, under Liz Truss–whom Meloni views as a role model. UK gilt yields have soared past Italy’s. Mortgage deals are being yanked. The pound has slumped against the US dollar and euro, with economist Olivier Blanchard noting Europe’s single currency should feel lucky that the UK never joined. Truss is now in danger of looking less like Thatcher and more like Mitterrand.

Markets are capable of irrationality, and Italy is also capable of bad surprises. But there is logic here. Italian political crises have been habit-forming, and investors feel they have the measure of Meloni’s playbook. Today’s eurosceptic politicians have learned from failed attempts to bring about their own Brexit or wage budget warfare on Brussels and bond markets at the same time. ‘Giorgianomics’ may still be an unknown quantity, but it leans toward negotiation rather than confrontation—or Italexit.

EU institutions such as the European Commission and the European Central Bank have also expanded their toolkits, creating more guard rails against furniture-throwers. The austerity mantra feeding populist anger has been softened with pandemic recovery funds worth €191.5 billion for Italy’s economy, provided targets and reforms are met. And Christine Lagarde’s crew has made clear their support for the euro with a bond-buying tool designed to prevent spillover risks—again, provided that eligible countries stick to post-pandemic commitments.

The UK isn’t Italy, economically or politically, yet it offers a cautionary market tale as it starts economic fights even populists in Rome would rather avoid. UK Chancellor of the Exchequer Kwasi Kwarteng’s announcement of large unfunded tax cuts in a mid-sized open economy, especially at a time of 10% inflation and 2.25% benchmark interest rates, is an invitation to sell even taking into account the UK’s relatively lower debt. As Bloomberg Economics’ Dan Hanson notes, the parallels with the early 1970s—when a “dash for growth" ended up stoking inflation and currency depreciation —are hard to ignore. International policymakers are rounding on the plan.

Here, a need to fight ‘the left’ is spilling over into markets. The hunt for a Brexit dividend in a low-regulation economy has exhausted market patience; Kwarteng’s scrapping of an EU-era bonus cap for bankers has failed even to get bankers excited. The more relevant Brexit effect has been post-2016 sterling weakness, more barriers to trade, a loss of European workers that has tightened labour markets and higher post-pandemic inflation. If economic ideas are getting more radical, it reflects a need for Brexit wins that prove UK exceptionalism. “We have come out of Europe and we have done nothing," says hedge-fund manager Crispin Odey, a Brexit supporter who has also bet on a fall in the pound. This is all made worse by an open conflict between the UK government and the Bank of England that looks most unlike the ECB’s past “whatever-it-takes" promise. Truss’s Tories want to slam the accelerator while the central bank wants to hit the brakes.

To be clear, this market dislocation is a snapshot in time—it needn’t last forever. What Nobel laureate economist Paul Krugman has dubbed the UK’s “moron risk premium" might be fully priced in.

In Italy, Meloni’s coalition government is still an unknown quantity. If Italy’s budget deficit isn’t improved, UBS Group AG reckons Italy’s debt-to-GDP ratio could rise to 162% by 2027.

But when even the UK can turn into an Italian-style market target, on account of sharp policy turn, it’s a warning nobody will forget in a hurry. 

Lionel Laurent is a Bloomberg Opinion columnist covering digital currencies, the European Union and France.

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