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Italy's government on the brink of collapse as deputy leader calls for elections

Key Points
  • There has been clear confrontation between the two-party coalition — formed of the leftist, anti-establishment Five Star Movement (M5S) and the anti-immigration, populist Lega party.
  • Lega is currently polling ahead of all other Italian parties at 38%.
  • "Let's quickly give the say back to the voters," Matteo Salvini, deputy prime minister and Lega leader, told the media Thursday evening.
ROME, ITALY - JULY 25: Vice Premier and Minister of the Interior Matteo Salvini holds a press conference on July 25, 2019 in Rome, Italy.
Simona Granati - Corbis | Corbis News | Getty Images

Political turmoil has returned to Rome with one of the country's deputy prime ministers calling for snap elections and declaring that the coalition government is unworkable.

The coalition has been on a rocky path since it first came to power in June 2018. There has been clear confrontation between the two-party coalition — formed of the leftist, anti-establishment Five Star Movement (M5S) and the anti-immigration, populist Lega party. The most recent clash happened earlier this week, when parliament rejected a motion by M5S to block a high-speed rail link — and thus support Lega which is in favor of the project.

"Let's quickly give the say back to the voters," Matteo Salvini, deputy prime minister and Lega leader, told the media Thursday evening. Salvini argued that the parliamentary vote on the high-speed rail link showed that the current government doesn't have the majority it needs to pass laws. However, critics of Salvini believe his willingness to have a fresh election is an attempt to capitalize on his recent rise in popularity.

Lega is currently polling ahead of all other Italian parties at 38%. It came to power as the junior coalition partner, but Salvini's tough rhetoric has helped to boost its popularity in a country where immigration is a key issue. M5S has, meanwhile, seen its support drop and is currently polling third at 17%.

Giuseppe Conte, the non-affiliated law professor appointed by both parties to serve as the country's prime minister, said Thursday that Salvini must justify to parliament why he is calling for a new vote.

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Federico Santi, senior analyst at Eurasia Group, said in a note Thursday: "The decision to trigger elections is not final by any means. Salvini's vaguely-worded statement leaves ample room for a compromise, and his statement could just be a way to throw his weight around."

The break up between the coalition parties only becomes official with a formal act — such as a no-confidence motion in parliament, a prime ministerial resignation or the withdrawal of ministers from the Cabinet.

After that, Italian President Sergio Mattarella needs to decide whether an election takes place immediately or if he appoints a caretaker government to pass the 2020 budget in the fall.

Uncertainty over 2020 budget

"The big question mark is whether Italy will go to elections quickly and quickly enough to have enough time for the new government to deliver a budget by year-end. This is the most important factor also for financial markets," Lorenzo Codogno, chief economist of LC Macro Advisors, told CNBC's "Squawk Box Europe."

He added the the timing of the move is "odd," given that Italian lawmakers are in summer recess and a snap election raises doubts about the country's 2020 budget plans.

There is no doubt … a government led by Lega would definitely go for more fiscal spending.
Lorenzo Codogno
Chief economist of LC Macro Advisors

Investors have focused on Italy's spending plans since the two-party coalition came to power. The country has one the highest public debt piles globally, above 130% of debt-to-GDP (gross domestic product). Therefore, the coalition's intentions to increase spending fueled market concerns and led to tensions with the EU.

Based on poll projections, analysts expect a Lega-led government in the event of a snap election. Salvini's party could join forces with the smaller far-right party Brothers of Italy (Fratelli d'Italia) to form a new executive. "In the unlikely event that either party significantly underperforms, they could still rely on the support of a third small right-wing party: Silvio Berlusconi's Forza Italia, or at least some of its sub-groups," Santi from Eurasia group said.

Wolfango Piccoli from Teneo Intelligence also said in a note Friday that "a Lega-dominated government will likely be more stable and coherent than the current coalition, with a heavy focus on immigration, law and order matters and lower taxes."

"Euroskepticism will be an integral component of such a government. While this does not necessarily mean that Salvini will pursue a referendum on the euro, the Lega's stance towards the euro/EU will remain ambiguous and contradictory, leading to recurrent clashes with Brussels," he added.

More spending ahead

"There is no doubt … a government led by Lega would definitely go for more fiscal spending," Codogno also said, adding that he expects further tensions between Rome and Brussels in the short term.

Italy's banking index dropped 4% in early European trade Friday and government bond yields rose. The yield on Italy's 10-year bond traded at 1.7630% at around 9:00 a.m. London time. Two days ago the same yield was below 1.5%.

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