The never-ending story

By Mike Peacock
October 1, 2013

Italian bond yields reversed a big chunk of their losses and stocks followed suit yesterday on the back of our scoop that 20 of Silvio Berlusconi’s senators had told him they could form a breakaway group if he pushed Italy into political chaos.

Whether they would switch their support to Prime Minister Enrico Letta and give him a workable majority in the Senate (he has a firm grip on the lower house) remains to be seen. That could buy several months of relative stability without the threat of Berlusconi mucking things up at any moment.

But we’re not anywhere near that yet and even then, elections would be likely in the spring. Those same senators did not speak out at a PDL meeting on Monday where Berlusconi said the party must push for early elections.

The next crunch point comes on Wednesday when Letta faces a confidence vote in parliament. He could woo independents and centrists under his predecessor Mario Monti in the Senate but that still wouldn’t be enough for a majority. He really needs to peel off some of Berlusconi’s supporters.

So, as we saw yesterday, the markets are prey to both upside and downside risk although more broadly we still seems to be in glass-half-full territory since there has been no sell-off on Congress’ failure to avert U.S. government shutdown on the apparent belief that it can’t persist for long without a deal being done.

The flip side, if it does persist, is presumably the Federal Reserve must keep its money taps full on.

The Italian government is, if anything, even more shut down and Fitch warned it could cut its BBB+ rating if efforts to cut the budget deficit stalled. Euro zone leaders are also watching, wary of any contagion. Angela Merkel called Letta to urge him to restore political stability.

Italy remains both too big to bail and fail but with the euro zone showing signs of recovery and investors still believing in the European Central Bank’s bond-buying backdrop it would probably take a prolonged standoff followed by a government that refuses to play the economic reform game to create a wider threat.

Much rests on the 88-year-old president, Giorgio Napolitano, and Berlusconi might have unwisely alienated him by suggesting he had exerted influence on Italy’s top appeals court in a case involving Berlusconi’s media empire.

Napolitano responded that it was “simply another delirious, vulgar and slanderous invention regarding regarding the head of state”. The president is the sole person with the power to dissolve parliament and call elections.

Longer-term, here’s one to ponder – Italy takes over the EU’s rotating presidency in the second half of next year.

Euro zone and UK manufacturing PMI surveys, together with the latest unemployment figure for the currency bloc, will give plenty of economic fodder to chew over.

We’ve already had flash figures for the euro area as a whole, Germany and France, and Britain’s recovery is now well in train. So perhaps the most interesting angle will be the ability of Italy and Spain to maintain the recent improvement in their figures.

Surveys have been strong through the last quarter, putting a question mark over the downbeat European Central Bank and German government forecasts for the second half of the year. The currency bloc as a whole looks set to pretty much replicate its 0.3 percent growth in the second quarter, nothing spectacular but a sign that recession is probably a thing of the past. The German economy rebounded strongly in the second quarter, growing by 0.7 percent. It might not quite match that in Q3 but it may not be far off.

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