Market reaction to Italy election outcome

MILAN (Reuters) - Giorgia Meloni looks set to become Italy's first woman prime minister at the head of its most right-wing government since World War Two after leading a conservative alliance to triumph at Sunday's election.

Following is some of the initial reaction from market observers:

STOCKS: Italy's FTSE MIB blue-chip index was up 1.3% in early trade before erasing gains.

BONDS: Italian bonds slightly underperformed their peers on Monday, pushing the Italian-German yield spread to a two-week high at 238 basis points. It last traded at 236 basis points.

NICOLA NOBILE, ASSOCIATE DIRECTOR; PAOLO GRIGNANI, SENIOR ECONOMIST, OXFORD ECONOMICS

"The election results have not deviated from voting intentions. Mainly for this reason, we are not seeing strong shocks in the markets, which, in line with our baseline scenario, assess that election promises, which if implemented would put Italian accounts at risk, will be scaled back or abandoned during the government's term of office.

"Risks in this area remain if the new right-wing government turns out to be less cautious than we expect.

"We had pinned some hope on Draghi's reform programme to chart a better growth trajectory for Italy, although we did not consider it our central scenario. However, given that the right-wing coalition has not emphasised structural issues in its election campaign or manifesto, we doubt that it will implement the necessary reforms."

LORENZO BATACCHI, PORTFOLIO MANAGER, BPER BANCA

"On the equities front, I expect - perhaps not in the short term - changes at the top of some state-owned companies such as Enel and Leonardo but not others such as Eni, which is extremely important at the moment, or Poste.

"Markets are not reacting to politics, it was expected. The weaker than expected performance for the League and Forza Italia (parties) may perhaps help the stability of Meloni's future government but we'll see this over time."

LUDOVICO SAPIO, ECONOMIST, BARCLAYS

"Near term, we think risks of tensions are modest, but could intensify in the medium term. The first priority of the government will be the completion of the 2023 budget law. Given the limited time available for its completion, we think the centre-right government may have to rely on the budgetary draft projections that the Draghi government will present by the end of the month.

"In the medium-term, we expect a centre-right government would bring a looser fiscal stance and a higher risk of frictions with the EU. In (a recent report) we quantify the budgetary impact of measures included in the centre-right manifesto to be around 30-70 billion euros (1.5-3.9% of GDP) including fiscal offsets; however, these will likely be implemented over time.

" The finalisation of some politically controversial NGEU reforms (eg. justice reform, competition law) could also be at risk, as these reforms have faced active opposition by the Brothers of Italy in parliament."

ALVISE LENNKH-YUNUS, DEPUTY HEAD OF SOVEREIGN AND PUBLIC SECTOR RATINGS, SCOPE RATINGS

"The important next steps to watch over the coming weeks are coalition negotiations, ministerial appointments particularly for the finance and economics portfolio, and discussions with the European Commission particularly over likely marginal changes to the NGEU recovery plan for Italy and associated reforms and fund disbursement."

FILIPPO MORMANDO, MACRO & EUROPEAN SOVEREIGN STRATEGIST, BBVA

"The lack of any major surprise in the outcome should arguably reduce the risk of any major shift in the markets' approach to BTPs at least as a first response (in either direction).

"Looking further ahead, the medium term perspective hasn't changed after the elections: in our view spreads are still somewhat tilted to the upside. From this standpoint, one of the most relevant driver for Italian bonds (and more in general for peripheral bonds) will be the net change in the sovereign paper supply/demand balance, that should lead to an increase in the net recourse to market to finance fiscal deficit and, secondly, the general pressure on the real yield component of European rates."

CHRISTOPHER DEMBIK, HEAD OF MACRO ANALYSIS, SAXO BANK

"The new government will have to scramble to put together a new budget for approval by the Italian parliament and the EU. Populist pressures could see the new government calling for large deficit spending that former PM (Mario) Draghi refused to consider."

"Meloni has promised to roll back some of the reform measures introduced by Draghi, a move that could risk the EU withholding some portion of the 200 billion euros of extraordinary EU pandemic budget funds targeted for Italy. This might increase tensions on the market but this is far from certain that a panic will follow."

ALESSANDRO TENTORI, CHIEF INVESTMENT OFFICER FOR ITALY, AXA INVESTMENT MANAGERS

"There is some widening in the spreads but it is nothing serious, also because we are seeing an upward movement of all interest rates. Now let's wait for the list of ministers and see if there are any critical issues.

"The weakness of the League could play in favour of the Brothers of Italy and a government more aligned with Brussels as a strong League may would have wanted to put in place some controversial ministers. (The League's weakness) could therefore be a positive signal for the markets.

"Today's upward movement is a continuation of the market reaction seen on Friday after Britain's mini-budget and sounds like a warning to the eurozone countries as well."

MATTEO RAMENGHI, CHIEF INVESTMENT OFFICER, UBS WM ITALY; THOMAS WACKER, HEAD CIO CREDIT, UBS

"Risk premiums for Italian government bonds have more than doubled from their pandemic lows and are trading around 230 basis points over 10-year German Bunds."

"We think investors in short- to medium-dated Italian bonds are well compensated for the risks resulting from Italy's high public debt burden and recurring episodes of political uncertainty."

"While the ECB is unlikely to intervene directly in reaction to moderately wider spreads, we believe it would ultimately act to rein in substantial distortions as long as Italy remains in agreement with the EU about fiscal budget policies."

PETER MCCALLUM & EVELYNE GOMEZ-LIECHTI, RATES STRATEGISTS, MIZUHO

"(Giorgia) Meloni's spending plans sound concerning at first glance, and may pressure the euro further in the near-term, but ultimately the EU's and ECB' TPI conditionalities should discipline the Italian Treasury and provide a backstop in case there is a blowout of BTP-Bund spreads. Meloni's political agenda remains to be clarified which is another risk to watch."

LUCA CAZZULANI, HEAD OF STRATEGY RESEARCH; LOREDANA MARIA FEDERICO, CHIEF ITALIAN ECONOMIST, UNICREDIT

"Some short covering is possible given investors entered the election moderately short BTPs and as the risk scenario of a landslide victory by the right is priced out. We continue to expect the 10-year BTP-Bund spread to trade close to 250 basis points until year end."

DOMENICO GHILOTTI, ANALYST, EQUITA

"From a market point of view, we expect the BTP-Bund spread to settle at around 230-250 basis points as we wait for the market to assess the composition of the government and the budget law, unless there is a change of tone from the new government or a marked worsening of the macro environment.

"Higher inflation on both 2022 and 2023 leaves some room to keep the debt/GDP ratio under control (higher tax revenues offsetting higher borrowing costs and pension spending)."

GIADA GIANI, ECONOMIST, CITI

"A clear-cut victory for one coalition makes it more likely that the next government will last longer than recent ones. It also speeds up the appointment of the new government, probably before end-October."

"Meloni's first key decision will be the appointment of the finance minister, with a pro-Europe, fiscally-cautious personality looking a likely choice for now. We do not expect an immediate push for a major fiscal relaxation, but we do see risks over the medium term that the right's policy agenda will clash with EU objectives."

LORENZO CODOGNO, CHIEF ECONOMIST, LC-MA

"The role of Forza Italia may be crucial for the centre-right coalition and therefore provide some guarantee on international alliances and the stance towards Europe.

"The PD weakened substantially, while the Five Star Movement scored well relative to opinion polls. All in all, despite some minor but important shifts, no major surprise. The new coalition's first steps will be crucial to see whether the reassuring signals are confirmed. Yet, many questions remain unaddressed".

(Reporting by Italy bureau; Compiled by Agnieszka Flak; editing by Valentina Za)