Euro Update: Italy – A political turn for the better

Europe works in its own weird ways, but it works. For the last four months, we had identified Italian politics as the single biggest risk to our call that the euro crisis will continue to fade. This risk has now receded further. Eight weeks after its inconclusive election, Italy got a new government on Sunday. The process was noisy und the Italian uncertainty contributed to a temporary setback for the euro economy. But the end result could be fairly positive.

Ahead of the election, the general assumption was that Italy would be governed by the centre-left headed by dour party apparatchik Bersani. He would have safeguarded the Monti achievements but not done much else. Instead, Italy now has Monti without Monti, namely a broad coalition of all those political forces which had backed Monti until last December. The new PM Letta has a much more centrist background than Bersani. Chances are that this new government could get a few useful things done.

With its 3% deficit-to-GDP ratio despite a deep recession in 2012, Italy does not need and will not get any further austerity. With less political uncertainty, the economy can spring back to life later this year. Of course, Letta faces serious challenges, for instance how to deal with the Berlusconi demand  of repaying Monti’s unpopular €8bn real estate tax. But under the stern guidance of super-president Napolitano, chances are that Letta will get around this hurdle as well.