What Next For Italy?

Italy is getting closer to putting together a grand coalition government. This has always seemed to us the most likely scenario, but the route to it has been circuitously torturous. Three considerations have led to President Napolitano granting the prerogative of forming a government to the deputy leader of the center-left, Letta.  

First, the unprecedented move to grant Napolitano a second term required an agreement between the center-left and center-right.  Second, such an agreement required the resignation of Bersani, the center-left leader.  His attempt to push Prodi's candidacy for President alienated not only the center-right, but also fractured his own coalition.   Third, Napolitano's leadership to force a coalition government, and in particular his decision not to push Amato's candidacy, which some local press had tipped, was important in breaking the political impasse.  

Amato's nomination would have alienated several of the smaller political parties on the right and left.  In addition, in terms of public support, Amato's tax on all depositors in 1992 has not been forgotten/forgiven and the sensitivity was heightened in light of the recent Cyprus developments, where the initial attempt to tax insured depositors was successfully blocked. 

Letta will meet with leaders of other political parties tomorrow and see if he can put together a cabinet that would pass a vote of confidence.  This will require a center-right candidate, though not Berlusconi,  as the deputy prime minister.  Alfano, the previous Justice Minister is a likely candidate.  Monti, the technocrat prime minister, is likely to get a portfolio.  However his austerity program was so unpopular, he is unlikely to get the finance ministry.  He may be of greater service in the foreign ministry.  

Renzi, the Florence mayor and rival of Bersani's is still a rising power and it is probably best he is not too closely associated with the coalition government.  However, one of most notably characteristics of both Letta and Renzi is their youth.  Letta, if he does succed in putting together a government, will be the youngest PM in Europe and Renzi is in the same cohort.    With high levels of youth unemployment and the sense that austerity is about a generation transfer from the young to the old, the transition to younger political leaders is a welcome development. 

We expect Letta to succeed in forming a government, which could be in place over the next week or so.   The coalition government will be fragile and the areas of agreement limited.  Electoral reform and some economic stimulus, especially in terms of employment, are two areas of potential common ground. The initial hope is that the government could last into Q1 next year.  

Current polls shows that the center-right would win an election if it were to be called now.  The center-left is in disarray.  Renzi's star is in ascendancy, but will take some time to mend fences.  Grillo's 5-Star Movement continues to play the role of obstructionist and has indicated it will not support Letta.  However, as we have noted, as the debate goes from first principles to specifics, some under the Grillo banner may support individual measures.  

Movements, like 5-Star, needs action and drama.  A coalition government, the decline bond yields (record low 2-year yield and lowest 10-year yields in nearly 3-years) and stronger stock market (6.6% this month)  removes some fodder for the discontents, though the economy itself remains in poor shape.  February retail sales were reported earlier today.  The 0.2% decline was more than expected and extends the streak of the lack of increases to ten months.  The 4.8% year-over year decline is the worst since last April. 

Italian banks do not appear to have returned much of their LTRO borrowings.  A new government and the lower market rates could encourage Italian banks to begin returning some funds.  This would add to the pace at which the ECB's balance sheet is shrinking.