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Italy remains poised for an anti-establishment leader

Key Points
  • The left-wing Five Star Movement (M5S) and the right-wing Lega have asked for more time to form a ruling coalition in Italy.
  • The two parties will put forward names to be the next prime minister.
  • President Sergio Mattarella will then have the final word.
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Italy's Five Star and Lega parties search for common ground

The left-wing Five Star Movement (M5S) and the right-wing Lega met the Italian president Monday afternoon to outline plans for a new coalition government, potentially breaking months of political deadlock.

However, as reported by Reuters, the head of M5S, Luigi Di Maio, asked the president for "a few more days" in order to reach an agreement on who will head the new coalition.

Giulio Sapelli, an economics professor, is supported by M5S but is reported to have ruled himself out. Lega is backing law professor Giuseppe Conte, according to Italian newspaper Corriere. President Sergio Mattarella will then have the final word.

If approved, the deal will avoid a repeat of the March general election. M5S was the most voted for party in the election but didn't receive enough votes to govern alone. Meanwhile, Lega saw a better-than-expected result and was endorsed to form a government with the backing from other right-wing parties.

Analysts expect that, if in place, the new government would mean a significant fiscal slippage. But, they are also confident that despite being from opposite ends of the political spectrum, these two parties will manage to overcome their differences.

Giles Keating, a managing director at wealth manager Werthstein Institute, told CNBC's "Squawk Box Europe" Monday that their political program has some issues that haven't been fully worked out.

"So cutting the pension age, universal income. But I think a flat tax … This is the sort of thing we've heard from America in the past, from many countries … it stimulates the economy," he said.

A flat tax would mean lower duties for companies and citizens and, thus, further economic strength for these people to spend.

Erik Nielsen, group chief economist at UniCredit, meanwhile, compared the Italian situation to what happened in Portugal.

"Before the present Portuguese government came to power (in 2016), many fretted about its policy promises, only to see a set of rather reasonable policies, which markets — slowly — turned out to appreciate very much," he said in a note Sunday.

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Flat tax worth giving a try in Italy, analyst says

Portugal is currently being governed by the socialist party, which is supported in parliament by the communist party (CDU) and the far-left Bloco de Esquerda (BE). At the start of their mandate, there were concerns that Portugal would increase public spending substantially and deviate from the reforms implemented during its bailout program. However, Portugal has registered one of the highest growth rates in the euro zone and credit ratings agencies have become more positive about its economy.

"While a M5S-Lega government might not align their policies quite as fast and effectively as the Portuguese did, I wouldn't be surprised if it comes close," Nielsen added.

An Italian government between M5S and Lega was the worst outcome in the minds' of investors before the election at the start of March. However, they have become more positive on such a prospect on the back of an improving economy and the presence of the monetary stimulus from the European Central Bank (ECB).

Looking at debt markets, the yield on the 10-year Italian paper hit a six-week high last week. However, it dropped slightly Friday following news of the potential deal between the two parties. Above all, the yield remains way below the euro zone crisis peak of 7.32 percent it hit in 2011. The main Italian index in Milan is also one of the best performing markets year-to-date across the globe.

Analysts are Rabobank said in a note Monday morning they are "neutral" as regards to Italian debt.

"In essence, we are caught between concern that investors will become re-sensitized to political risk and an unquantifiable hunch that the lure of positive carry may continue to support the market," they said.