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Italian banks face expensive funding, volatile economy as snap election looms

With a snap election on the cards and the coalition government in crisis, Italian banks will have to contend with higher funding costs and a more volatile economic environment, according to Scope Ratings.

Italian Deputy Prime Minister Matteo Salvini on Aug. 9 called for fresh elections after his League party hit an impasse with its coalition partner Five Star Movement. Elections are likely to take place in the second half of October.

The relationship between the two coalition parties had been fraught for some time, with disagreements over fiscal policies and the relationship with the EU, but it was a disagreement over a rail-link project opposed by the Five Star Movement but supported by the League that brought matters to a head.

For Dennis Shen, director in Scope Ratings' public finance team, the news did not come as a complete surprise, as the possibility of an early election in Italy has been on the cards for some time. Scope downgraded Italy's sovereign rating to a "stable" BBB+ rating in December 2018 from A- and the fragility of the coalition government was one of the factors behind the decision, Shen said in an interview.

But the snap election could contribute to further weakening in the Italian economy, which is already in a vulnerable state, Shen said in a note shared Aug. 9.

"The further injection of political uncertainty, while it may not be consequential for long-run growth prospects, will hamper investment in the short-run," he said.

Scope forecasts that Italian GDP will grow by 0.2% in 2019 and 0.6% in 2020, with the medium-term growth potential estimated at 0.7%, according to the note.

Banks feel the pain

A "degradation" in the economic environment could be a risk for Italian banks, as could the prospect of more expensive funding, Shen said in an interview.

Bond spreads have widened in the past few days, he noted.

"The Italian 10-year yield is up approximately 40 basis points since midweek to 1.8%, with the spread to Germany picking up to about 235 basis points," he said.

Shares in Italy's largest banks took a hit on the news of the snap election.

UniCredit SpA shares fell by 5.13% on Aug. 9, while Intesa Sanpaolo SpA was down 3.63%, Unione di Banche Italiane SpA was down 8.42% and Banca Monte dei Paschi di Siena SpA fell 8.54%.

Fitch Ratings is set to publish the results of its Italian ratings review after market close Aug. 9. Its sovereign rating of Italy currently stands at BBB, two notches above investment grade, with a negative outlook.

The team of analysts at UniCredit said Fitch's decision about whether to hold or downgrade Italy's sovereign rating could go either way.

"Fitch's assessment of the vulnerabilities of the country is likely to focus on the high level of public debt, the low growth trend and continued high political uncertainty," the note said.