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 While polls suggest Prime Minister Enda Kenny's Fine Gael is likely
to win Friday's election, a collapse in support for junior partner
Labour suggests the two parties will struggle to hold onto power.
An unprecedented tie-up with old rival Fianna Fail might be one
option for Fine Gael, but an alliance of the established right-wing
parties could prove unstable and, crucially for investors, hand
hard-left Sinn Fein a platform in opposition.
No major policy changes are expected in Ireland, which has recovered
from a 2010 sovereign bailout to become the fastest-growing economy
in the European Union but investors are always concerned about
political instability.
Those worries are being exacerbated by the June 23 referendum in
Britain -- Ireland's neighbour and one of its biggest trading
partners -- on whether to leave the EU.
"The timing for Ireland has been unfortunate in that we have the
Brexit campaign kicking off in a week where we also have an
election," Commerzbank strategist David Schnautz said.
"We know Ireland is very different to Spain and Portugal, but
investors have learnt that these domestic political events are to be
treated with caution even if you think a hung parliament will not be
a negative game-changer."
A fragmented result would mimic recent election outcomes in Portugal
and Spain, where anger at austerity, some imposed under bailouts,
perceptions of rising social inequality, and mistrust of established
political elites split votes.
Irish 10-year bond yields edged up on Friday to 0.93 percent,
underperforming euro zone peers on a day that Spanish and Italian
equivalents fell to three-week lows.
Irish yields remain in sight of record lows of around 0.60 percent
struck in 2015, however, and are far from highs of 15 percent seen
at the height of the euro zone crisis in 2011.
On economic metrics they should be doing even better though.
Irish growth, budget deficit and borrowing figures all look better
than those of France, whose economy continues to struggle, but their
yields have been diverging in the months leading up to the election.
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The gap between the two countries' borrowing costs hit its widest
level in eight months earlier this week, up fivefold from levels
seen in January.
This shows investors may be getting itchy feet. Franklin Templeton,
which held 10 percent of the Irish bond market after the country was
bailed out, has sold its position while funds like Aberdeen Asset
Management have scaled back their exposure.
Investors are also worried that any political upheaval could slow
Ireland's response to a possible Brexit scenario, which an Irish
government report estimated could see trade between the two
countries fall by at least 20 percent.
Yet some analysts expect a measured response from markets.
"Whatever the outcome, a departure from the path of fiscal
consolidation does not look probable," DZ Bank strategist René
Albrecht said.
"Ireland's solid economic recovery has convinced many Irish citizens
that the government is pursuing the right political tack -- unlike
in other EMU states, extremist positions have only played a
subordinate role in the election campaign."
(Reporting by John Geddie; Additional reporting by Dhara Ranasinghe;
Editing by Catherine Evans)
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