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France is frightening the market, but Italy could be the real threat for investors

Giuseppe Ciccia | Pacific Press | LightRocket via Getty Images

Italy poses the greatest threat to stability of the euro area in spite of the impending presidential elections in France, according to analysts at Deutsche Bank.

Italy's former Prime Minister Matteo Renzi resigned as leader from the ruling Democratic Party (PD) on Sunday which appears to have sounded the alarm that a formal party split could be in the offing.

"Italy represents, in our view, the main risk to euro-area stability," Marco Stringa, senior economist at Deutsche Bank, said in a note.

The increased likelihood of a PD party split, which has now become Deutsche Bank's base case scenario, has resulted in the yield spread between Italy and Germany's 10-year bonds widening by the most since February 2014.

Analysts at Deutsche Bank projected that September would now be the most likely time for elections to be held in Italy as they argued Renzi would wish to hold the vote before he is required to send the 2018 budget draft to the European Commission in October.

Meanwhile, in France, elections for the new French President are due to take place in a two round process beginning in April and ending in May. Marine Le Pen, leader of the anti-establishment National Front party, has promised to renegotiate the terms of France's membership of the European Union if elected president, though her chances of success appear limited.

"We think that the probability of a negative development in Italy in the short- or medium-term is greater than a victory of the leader of the National Front, Le Pen, in the forthcoming French presidential election," Stringa added.

Election assumptions in peril

Investors appear increasingly nervous about the prospect of several scheduled elections in Europe this year having failed to predict the outcomes in the U.K's Brexit vote as well as U.S. President Donald Trump's victory in 2016.

In France, ahead of the election in May, left wing candidates Benoit Hamon and Jean-Luc Melanchon confirmed on Friday they had held talks to discuss forming one single candidacy in order to boost their election prospects.

Analysts at Mizuho and Deutsche Bank both concluded that should Hamon and Melanchon form an alliance to strengthen the socialist offering, the assumption that Le Pen would be beaten in the second round by an establishment candidate would be challenged.

"Such an alliance, if it was to materialize, would put the assumption that Le Pen will be beaten by Macron or Fillon in the second round in peril," a team of analysts at Mizuho said in a note.