The complex machinations of the government-formation process have been continuing in Italy over the past few days. The names of ministers in a future “technical” transitional government were already leaked to the press on Wednesday. Shortly afterwards, however, the M5S and the Lega asked State President Mattarella for a further reprieve so as to be in a position to put together a government from the two populist camps at the eleventh hour. The odds of this constellation emerging increased significantly when Silvio Berlusconi’s Forza Italia signalled that it would no longer put up any resistance to such a coalition. Negotiations between the M5S and the Lega, which together can muster 351 deputies, a clear majority, in Italy’s 630-seat parliament, will presumably drag on over the coming weekend. Despite – or perhaps even because of – the long-drawn-out negotiations which have taken place since the 4th March election, the latest reports are already pointing to a decidedly concrete configuration for a possible new government. For instance, both Lega Chairman Salvini and M5S boss Di Maio have declared that they will not be standing for the post of prime minister – this critical bone of contention had previously seemed a virtually insuperable obstacle. Instead, second-rank politicians are now being touted as possible premiers, for example Giancarlo Giorgetti (Deputy Secretary General of the Lega), or Giulia Bongiorno (Lega) or else independent candidates such as Enrico Giovannini (former head of Istat) and Alessandro Pajno (President of the State Council). The Italian press is speculating that Di Maio could become Foreign Minister and Salvini Minister of the Interior, with both holding the title of Deputy Prime Minister.
By the beginning of next week, it should be clear whether the two parties which emerged with the most votes from the 4th March election have indeed been able to forge an agreement or not. Although a last-minute breakdown of the talks cannot be completely ruled out in view of the numerous twists and turns of Roman machinations – a breakdown scenario would ultimately lead to the transitional government referred to at the outset – an administration composed of the M5S and the Lega looks to be more realistic than ever after the events of the past few days. From the market’s perspective as well as from the economic-policy and Europe-policy viewpoint, such an alliance would probably be the worst-case scenario; after all, the two parties are united above all by their criticism of the EU and of fiscal austerity measures. While a possible Minister of the Interior Salvini might well cater to nationalistic tendencies (which, on the refugee issue, could ultimately radiate right across Europe), Di Maio as foreign minister would probably deepen the worry lines on faces in Brussels. With regard to Europe policy, both parties have admittedly avowed their commitment to Europe and the euro of late, but they have also demanded that the existing framework parameters should be amended. Especially when it comes to the EU Sixpack (inter alia: surveillance of budgetary positions and implementation of the excessive deficit procedure), there are likely to be louder calls from Rome to loosen the criteria. This could also lead to more difficult negotiations concerning Macron’s E(M)U reform plans, which are likely to be on the agenda at the EU Summit scheduled for 28/29 June. Proposals which could transfer more power to the EU would probably run into more entrenched opposition, not only in Rome. Were Italy indeed to violate the Stability Pact in the years ahead, the European Commission would hardly seem up to the task of rectifying the situation in view of its far from successful history as a surveillance and law-enforcement authority. This would probably put the German government – whose response to Macron’s reformist zeal has so far been decidedly wan and lacklustre – in even more of a pickle, further increasing the resistance against “more Brussels,” for example in Mrs. Merkel’s CDU/CSU parliamentary group.
Italian bonds continue to react with concern to these developments: at 137 bp, their 10-year Bund spread hit the highest level since mid-March on Thursday, only marginally below the interim highs scaled in the vicinity of the election. Despite the slight rebound in evidence this morning, we do not think the latest spread widening is the end of the road.