(Bloomberg) -- European shares enjoyed a reprieve on Friday, waving aside lingering political questions, after Italy’s populist parties scraped together a new government to end a three-month deadlock while Spanish Prime Minister Mariano Rajoy was ousted.
The Stoxx 600 advanced 1.3 percent, set for the best day since early April, and paring its biggest weekly drop in more than two months. The biggest losers from the selloff rebounded the most on Friday, with banks outshining all other sectors. The Italian benchmark headed for its biggest gain since early February.
“European equities have risen and bond yields have fallen as investors welcome an apparent end to the political uncertainty in Italy,” Chris Payne, managing director at GWM Investment Management, said. “With the impact Italian politics had on markets earlier in the week, we are expecting the situation in Spain to provoke a similar reaction.”
The two political sagas in Italy and Spain came to an end over the past day, bringing relief to global markets. In Italy, tumultuous political negotiations concluded with a new populist government, while in Spain, a vote in parliament saw Socialist leader Pedro Sanchez take over Rajoy. Even U.S. tariffs on steel and aluminum imports from regions including European Union seemed to be doing little to dent the relief rally.
Yet the worries that had rocked markets still persist. Italian assets slid earlier on concern a populist program would put the country further in debt and undermine relations with the European Union. If the new administration insists on unrealistic fiscal goals and escalates their rhetoric, market tensions will likely resurface and potentially harm economic confidence, strategists led by Yianos Kontopoulos at UBS Group AG wrote in a note.
In Spain, Sanchez will govern thanks to an alliance that includes anti-establishment group Podemos and the Catalan separatists who were trying to break up the nation six months ago. He could hang on to power until 2020 or call early elections. Investors will also have to see whether Sanchez will keep Spain on a trajectory of improving economic growth and fiscal health. The IBEX Index extended gains after the vote against Rajoy and was trading 2 percent higher as of 3:00pm in Madrid.
“In Spain, the market expects early elections to be called and in the meantime it will all depend on what Sanchez does,” Jacobo Blanquer, partner at Madrid-based asset manager Tressis Gestion said by phone. “If he maintains the reforms the previous government put in place, investors will see it as a stand-by situation, while if he starts making large changes jitters could return to the market.”
The return of European political risk on asset managers’ radar screens has sparked “massive outflows” from the region’s stocks, according to a note from Bank of America-Merrill Lynch strategists. In the week to May 30, Europe equity funds saw redemptions of $4.5 billion, marking a 12th straight week of outflows.
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