During the recent European parliamentary elections, Italy saw a significant reframing of its government's political dynamics.
Even if you discount for the fact that EU elections typically attract a significantly lower turnout than national polls, it was still striking that the government's junior coalition partner, the anti-immigration and euroskeptic Lega party, saw its popular support double from the 17% of voters it attracted in last year's general election. The anti-establishment, anti-austerity Five Star Movement (M5S), which had won roughly a third of all votes in those elections last March, meanwhile watched its support crumble by half.
Italian political stability has long been an oxymoronic punchline, with the current government under Giuseppe Conte the 66th to form since World War II. But after a year of often fractious partnership the two deputy prime ministers, Lega chief Matteo Salvini and Luigi di Maio of M5S, appear to be even less simpatico than was the case when they announced their surprising tie-up last May after months of post-electoral wrangling.
The past twelve months have provided no end of drama, gossip and intrigue for political observers in Rome, with cabinet ministers fired amid corruption allegations and insults hurled publicly at senior European Commission officials during disputes over Italy's finances. But for investors — and particularly the owners of Italian government debt, among them most Italian banks — this continued instability, and now the latest round of political uncertainty engendered by the EU election results, has become less of a genteel spectator sport and more of a gut-wrenching roller-coaster ride.
In an interview last week, the governor of the Banca d'Italia, Ignazio Visco, told me the yield on Italian government debt was "too high." But he was at pains to point out in the central bank's annual report on Italy's economy that the country's household and corporate debt levels are lower than the European average. He told me Italy has to be "credible in the ability to reduce the burden of debt," and that investors must perceive that credibility "starting now" to avoid the possibility that businesses and consumers start really feeling the impact of the state's high borrowing costs. The prospect that this would happen soon, Visco concluded, was now "close to a razor edge."
One solution to reignite Italy's sluggish growth, Visco argues, is to "harmonize and recompose" the country's antiquated and disjointed tax code. This suggestion was seized on last week by Salvini, who has tried but so far failed to prioritize lower taxes, and in particular proposals for a flat tax rate. But with any attempt to reduce taxes, writes Lorenzo Codogno, former chief economist at the Italian treasury department, "the Lega may soon enter a collision course with its ally," warning that the market had proved "ultra sensitive" to political or fiscal announcements or changes.
Salvini told me ahead of the European elections that he had no plans to call it a day with his M5S coalition partners. But after a strongly worded public statement on Monday evening, it is clear that the coalition's consensus choice for prime minister, professor turned political peacemaker Conte, is no longer prepared to wait any longer for these two parties to end their public feuding and address Italy's long list of challenges.
However, for investors concerned about a fresh set of national elections or another battle royale with Brussels, there are those who continue to counsel calm. Wolfango Piccoli, the co-president of political intelligence consultancy Teneo Intelligence, wrote in a recent research note to clients that the "base case remains that Italy will not return to the polls." He also insists that it is "somewhat doubtful" that a newly-installed European Commission will take a hard line on Italy and try to initiate an excessive deficit procedure that would further damage confidence.
Last year. Banca d'Italia's Visco published a book about Italy's challenges as it emerged from the 2008 financial crash and the European sovereign debt crisis. He titled it "Difficult Years." I asked him on Friday how his country's current set of circumstances stacked up in the context of that era. He responded with a smile and the laconic understatement you often expect from a central banker. "This year is difficult."