Global market outlook: Increasing risks in Italy and the Eurozone

20 December 2018 | Markets and Economy



Alexis Gray, senior economist, Vanguard Europe

Leo Schulz (moderator): The recent dispute between Italy and the European Commission once again highlighted strains in the Eurozone. My name is Leo Schulz and I have with me Alexis Gray, senior economist at Vanguard Europe.

Alexis, this dispute between Italy and the European Commission, how did we get here?

Alexis Gray (senior economist, Vanguard Europe): Well, there were elections held in Italy earlier this year where the two parties that gained the most support were often described as “populist” and “Eurosceptic” in their sentiment, and they campaigned, really, on a promise to end years of austerity, so naturally when they were elected into power, they promised to raise spending and they put forward a budget that was much more positive than in the past. Now, the European Commission who governs the Eurozone has basically rejected this budget and so now there is some tension about what will happen and whether some penalties are going to be applied.

Leo Schulz: Alexis, in a way, this is an episode in a much longer story. If we think over the past 10 years, there have been a number of times when the euro has come under strain and not just with Italy, but we can think of other countries as well, Greece obviously, Spain and so on. Are there underlying issues that are affecting the Eurozone?

Alexis Gray: There are inherent difficulties in managing a currency union. This is well known. When countries come together and they give up their home currency and share one exchange rate, they lose the ability to adjust when shocks hit the economy, positive or negative, and so that adjustment, rather than happening by the exchange rate, needs to happen inside the economy. For example, a firm might lower wages in order to be more competitive on cost when competing outside the country. So what we have seen is sort of a case of winners and losers, at least over short periods of time, and that is where some of these crises have come up.

Leo Schulz: In this current situation, do you see a situation in which Italy might withdraw from the euro?

Alexis Gray: It is certainly possible, but in our view the risk over the next several years is relatively low - we think less than a 10% chance that Italy leaves the euro. Clearly, there are tensions but, I think, the government has signalled a willingness to exhaust all other options, because an exit really wold be quite painful.

Leo Schulz: Alexis, what is the impact on investors?

Alexis Gray: For investors, these types of geopolitical risks may cause concern, but they exist across the world. We have seen numerous examples in recent years, and so it is very difficult not to be exposed, at least, in some part of your portfolio. If anything, I think, it underscores the importance of having a globally diversified portfolio across asset classes to minimise downside risks.  

Leo Schulz: Alexis, thank you very much.

Thank you for watching.

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