Markets have been shaken by political turmoil in Italy, where the formation of an interim government of unelected technocrats has been delayed.
What is happening in Italy?
The failure of new prime minister-designate Carlo Cottarelli to form a cabinet has sparked political upheaval that is likely to lead to new elections.
Investors believe the vote could see Italy moving closer to abandoning the euro if the populist League Party and Five Star Movement gain more ground in any poll.
That could have major implications for the European financial system and its economy.
How have markets reacted?
Badly. Italy’s political turmoil has stoked fears of instability in the eurozone, causing stocks to fall globally and knocking the single currency.
Investors have also dumped Italian government bonds, driving borrowing costs sharply higher for the country and rekindling fears of more financial strain for Europe’s third-largest economy.
Impact on Britain’s economy?
Britain is not in the eurozone and UK banks have already reduced their exposure to Italy, so the impact is limited, for now. However, the FTSE 100 has been pummelled, with £25 billion wiped off the value of the blue chip index on Tuesday.
President @JunckerEU convinced that #Italy's fate does not lie in the hands of the financial markets:— European Commission 🇪🇺 (@EU_Commission) May 29, 2018
âItaly is a founding member of the EU that has and will continue on its European path. Italy deserves respect.âhttps://t.co/fSFVE7yPUb
Italy abandoning the euro would also be bad for Europe as a whole as it would be likely to trigger a financial crisis in one of the continent’s biggest economies.
The pound would normally benefit from a continental crisis as investors flock to safe haven assets, but since the Brexit vote the pound has fallen out of favour and has moved up only marginally against the euro.
Political implications for the UK?
Analysts fear that the Euroscepticism of the League Party and Five Star Movement could ultimately spill over into a Brexit-like disaster where Italy not only crashes out of the single currency but also out of the EU.
But that is a long way off and Britain has its own political crisis brewing. Theresa May’s Conservative Party is yet to ink a Brexit transition deal or give any indication whatsoever of how it plans to honour its pledge to deliver the “exact same” benefits of EU membership from outside the bloc.
What are the experts saying?
Some believe that a full blown crisis is under way. Others, such as UBS chief economist Paul Donovan, think it is overblown.
“Everyone needs to take a deep breath and calm down,” he said.
“Bond market moves do not break up monetary unions. Bank runs do. There is no evidence of bank runs. Neither Italian parties nor Italian voters support leaving the euro.”