International banks are turning their attention to the Irish election and directing investors to the uncertain outlook for the poll.

Taoiseach Enda Kenny is widely expected to call a February election this week, with polling day on Thursday the 25th or Friday the 26th.

The onset of the campaign comes with 10-year Irish borrowing costs under 1 per cent, suggesting that Dublin is seen as a “semi-core” debt issuer with yields well below other euro zone crisis countries.

Large-scale bond-buying by the European Central Bank has helped to ease Irish yields. Another key factor is the assumption in markets that an election “shock” is not a prospect.

In line with political analysts, financial market observers expect the return of a Fine Gael-led government.

While international assessments accept that the ultimate composition of the next administration remains unclear, some traders warn privately that the possibility of an unstable outcome may be greater than recognised outside Ireland.

With this in mind, they say polls suggest that Fine Gael and Labour remain very far from a Dáil majority.

In a note to clients late last week, however, BNP Paribas said that “the chances of a market-unfriendly outcome are limited”. According to the bank, the Fine Gael-Labour Coalition “appears to be in pole position” to win a second term.

“If it falls just short of a majority, it could bring a smaller party or independents into government,” BNP Paribas said.

“An unexpectedly poor showing for the coalition might force Fine Gael into an alliance with Fianna Fáil rather than its current partner,” it added. “A straight Fine Gael win looks less likely.”

Well short

In a note, Royal Bank of Scotland, owner of Ulster Bank, said bookmakers expect FG- Labour to win some 69 seats in the next Dáil, “well short” of a majority.

“Both Fianna Fáil and Sinn Féin have said they would not enter a coalition with FG, so if it is to form a government, the party might therefore have to rely on smaller parties – such as Renua or the Social Democrats,” RBS said.

Given the very low rate at which Irish debt currently trades, market participants said Irish borrowing costs could rise suddenly if polls during the campaign point to a hung Dáil, with no obvious combination in command of a majority.

The emergence of any such trends in pre-election polls could lead markets to conclude that Irish debt was mispriced, said one senior figure.

Continuing stability

Market assessments of the election are predicated on a continuation of stability vis-à-vis the public finances. Any change to that outlook could put upward pressure on Irish bond yields.

If Fine Gael-Labour has no majority, BNP Paribas said an alliance with the Social Democrats was more probable as Fine Gael’s split with Renua TDs was not amicable.

“Things get more difficult if the coalition needs more than three or four seats,” it said. “A few additional seats could be gained by bringing in some independent politicians, but it becomes very messy to do deals with more than a few independents in addition to the Social Democrats or Renua.

“If the coalition needs something in the region of 10 seats,” it said, “ other options need to be considered. A government including Sinn Féin’s left-wing agenda would probably be seen by the markets as an undesirable outcome.

“It is hard to see any party willing to enter government with Sinn Féin, given its controversial past in Northern Ireland. For us, this outcome looks very unlikely.”