Italy's New Leader Throws Down Gauntlet on Austerity

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Italy's political deadlock may be over after the country's President nominated center-left politician Enrico Letta as prime minister on Wednesday, but Letta has already fired a shot across Europe's bows on austerity.

Letta is viewed as a moderate with allies in every political party. He is the nephew of Berlusconi's chief of staff, Gianni Letta but has been the deputy head of the center-left Democratic Party (PD) since 2009. On Thursday, he is to start talks with other party leaders on forming a grand coalition with former prime minister Silvio Berlusconi and his center-right bloc.

(Read More: Italy's President Invites Letta to Form Government)

The end to the impasse means Italy won't have to return to the polls right away. But Letta's comments after he accepted the premiership have thrown Italy's austerity program, introduced by technocrat leader Mario Monti, an economist by training who had the support of Brussels and Germany, into doubt.

"European policies are too focused on austerity which is no longer enough," Letta said after accepting the mandate to govern from 87-year old President Giorgio Napolitano.

"The country is waiting for a government. Everyone knows this is a situation that cannot go on like this," Letta said, adding that politics in Italy had "lost all credibility."

(Read More: Hollow Victory for Italy as More Turmoil Looms)

One analyst told CNBC on Thursday that despite Letta's anti-austerity comments, the new Italian prime minister will have good relations with the European Union.

"From the European point of view, Letta's appointment is good news. It's certainly much easier imagining Germany's Chancellor Angela Merkel having a tough conversation with Letta, rather than say with Berlusconi or even other figures within Letta's PD party," David Lea, a senior European analyst at risk consultancy Control Risks told CNBC.

"Letta has been saying that he's not a huge supporter of austerity, he very much backed (Jose Manuel) Barroso's words when he suggested that austerity might be a policy that had had its day. There are elements in Italy, such as the property tax, that have gone down very badly in Italy. So I expect he will roll back some of Monti's more technocratic reforms in that area," Lea told CNBC Europe's "Squawk Box."

(Read More: Italy's Political Chaos Deepens on Presidential Vote)

Meanwhile, Letta said on Wednesday that he was ready to work with his rivals to tackle labor and institutional reforms but said he would not form a government "at all costs" signalling that he would resign if the parties did not work together.

Italy's public debt pile has risen to a record 2 trillion euros ($2.64 trillion) and Letta will have to counter demands from parties such as Berlusconi's to cut taxes.

Investors will be watching closely. European economists at Barclays and Morgan Stanley said it was too early to say whether the grand coalition will be strong enough to deliver structural reforms, and added that Italy's economic future was uncertain.

"This…might perhaps mark the beginning of a less volatile period in Italian politics," Daniele Antonucci, European economist at Morgan Stanley, said in a note on Wednesday. "But whether it paves the way toward paying the many 'policy arrears' that are long overdue remains to be seen."

Stephen King, chief global economist at HSBC, told CNBC that a fractious coalition government posed a risk to structural reforms.

"If the coalition hangs together that would be relatively good news but the reality with grand coalitions is that you have initial desire to get things going, but ultimately there is no real agreement about the nuts and bolts that needs to be done," King told CNBC's "Closing Bell" on Wednesday.

"Looking at the history of Italian governments in the last 50 or 60 or 70 years one not ought to be particularly optimistic. One of the big tests for Italy, and southern European countries in general, is to what extent they deliver the austerity that northern Europe would like to see with possibly, relatively weak governments."

-By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt

Maria Sovago contributed reporting to this story.