(Corrects surname in 17th paragraph to read Gargour)
By Simon Jessop
LONDON Feb 21 An inconclusive result in Italy's
elections this weekend could prompt an even bigger sell-off in
some markets than the return to power of scandal-mired Silvio
Berlusconi, who led the country to the financial precipice in
Italian stocks, bonds and, to a lesser extent, the euro are
all expected to rise if, as the latest polls suggest, the
centre-left led by Pier Luigi Bersani wins a majority in the
lower house and forms a stable pact in the Senate with outgoing
centrist Prime Minister Mario Monti to head a reform-minded
But prices will fall if Italy, whose mountainous debts
catapulted it to the forefront of the euro zone debt crisis
under Berlusconi 15 months ago, emerges from the Feb. 24-25
election with a hung parliament incapable of producing a stable
administration, analysts say.
Italian debt and shares sold off sharply in recent weeks as
Berlusconi made big gains in opinion polls. However, with his
centre-right party lagging the centre-left by 4-5 points in the
final polls before a pre-election blackout, markets have largely
discounted the return to power of the media tycoon, who has been
weakened by a string of sex and financial scandals.
"I am inclined to think the centre-left and centre will have
control, but the marketplace as a whole is reasonably complacent
about the risk we do not get that outcome," said UBS currency
strategist Geoffrey Yu.
On the surface, markets appear calm just two days before
voting. Italian stocks had regained half their 4 percent
political risk-driven fall by Wednesday, and 10-year bond yields
were off their recent highs.
Italy's blue-chip stock index, the FTSE MIB, having
started 2013 strongly, is nursing losses for the year and
lagging the pan-European Euro STOXX 50 and national
indexes in France, Germany and Britain.
Antonin Jullier, global head of equity trading at Citi said
a centre-left/Monti win could push shares higher.
"There is another 2 percent to grab in both the E-STOXX 50
and the FTSE-MIB if the result goes for Bersani-Monti," he said.
Aviva Investors reckon the gain under such a scenario could
be as much as 5 percent, with the most market-neutral event
being an outright Bersani win and the worst not a Berlusconi
victory, which could prompt a 2 percent fall, but a hung
parliament, which could see stocks fall 5 percent.
That fear has driven the cost of protection against a fall
in the FTSE MIB to its most expensive since mid-September.
Italy's borrowing costs have fallen sharply since Monti
formed his technocrat administration in November 2011. This is
in large part due to last year's pledge by European Central Bank
President Mario Draghi to do "whatever it takes" to save the
euro and subsequent offer to buy the bonds of struggling euro
zone countries that seek help - the so-called 'Draghi put'.
"Our perception is that the Draghi put is working, and this
has changed the game to the benefit of peripherals," Commerzbank
fixed income strategist Michael Leister said.
But there's a lot of paddling beneath the calm surface, with
volumes in Italian bond futures at their highest four-week
moving average since the contract was launched in 2009, a
Reuters analysis shows. That means there are still plenty of
investors bailing out of Italian bonds, while others, reassured
by the ECB's back-stop, have been snapping them up.
A hung parliament would see yields, which move inversely to
prices, jump, with a knock-on effect in the rest of the euro
zone periphery, especially in Spain.
William de Vijlder, chief investment officer of BNP Paribas
Investment Partners, said a stable reformist government could
see 10-year yields fall towards 4 percent from
levels around 4.9 percent, while stalemate could push them up
towards 5.2 percent.
Louis Gargour, CIO of hedge fund firm LNG Capital, said a
Berlusconi win could push Italian yields up 75-100 basis points.
Even that would leave yields below the unsustainable levels
above 7 percent hit in late 2011.
Hedge funds were also betting on an expected rise in
volatility in the euro's exchange rate against the dollar early
next week, a chief options trader at a large European bank said.
"People are definitely heading into the election a bit more
cautious. There was a lot more selling last week and a defensive
stance," UBS's Yu said, adding a shaky coalition could see the
euro fall to $1.30 from current levels around $1.32.
Dagmar Dvorak, director of currency and fixed income at
Barings Asset Management, said the fund was underweight the euro
before the election.
She also said the euro could fall to $1.30, but expected
more reaction in bond markets as the single currency was
supported by the ECB's policy stance.
"I don't expect a sharp move down in the euro. It is still
supported by (the ECB's) balance sheet contraction versus
(Additional reporting by Anirban Nag, Nia Williams, Emelia
Sithole-Matarise, Toni Vorobyova, David Brett, Laurence
Fletcher, Alistair Smout, Marius Zaharia, Sudip Kar Gupta,
William James, Francesco Canepa and Annika Breidthardt; editing
by Nigel Stephenson and Will Waterman)