European ‘Defragmentation’ Risks Re-Emerge As Italian Political Crisis Looms

Italian stocks and bonds are reeling (yes, again) as political risk soars back to top of mind after the Five Star Movement set to boycott a key aid package vote, putting the survival of Prime Minister Mario Draghi’s government at risk.

Giuseppe Conte, the Five Star party leader and the second-biggest group in Draghi’s coalition, said he could no longer back Draghi’s cross-party government, which he accused of not doing enough to help families battered by spiralling food and energy costs.

“I have a strong fear that September will be a time when families will face the choice of paying their electricity bill or buying food,” he said after a day of frenetic political consultations.

Crucially, as The FT reports, the implosion of the national unity government, which could trigger earlier elections that were set for spring next year, would come at a sensitive time for Italy, which is expected to be the largest single recipient of the EU’s €750bn Covid recovery fund.

Draghi, who has been leading Italy’s technocratic government since early 2021, is expected to meet President Sergio Mattarella on Thursday afternoon, and could offer his resignation.

Other parties have indicated that they could call for an early election and that it was untenable for Draghi to remain in power if Five Star pulled out. In an interview with Italian paper Corriere Della Sera on 15 June Matteo Salvini, head of the rightwing League, argued that the government’s balance has moved “too much to the left” on many dossiers, such as taxes, pensions, immigration and justice.

“If a coalition party doesn’t back a government decree, enough is enough, it seems clear that we should go to elections,” said Salvini.

European Union Commissioner Paolo Gentiloni, a former premier of Italy, said the EU is concerned by the Italian situation.

As Rabobank’s Michael Every notes, polls suggest that the far-right Brothers of Italy would come out on top if elections would be held right now. The worsening financial position of households only has strengthened their chances of winning such elections, since they are basically the only big opposition party.

Italy’s FTSEMIB is Europe’s worst-performing equity index this morning (led by its banking sector’s weakness), breaking back below last week’s lows back to its lowest level since Nov 2020 (notably over 19% below pre-COVID highs)…

The Euro is weakening further also (against the USDollar)

Additionally, and more problematically for The ECB, Italian bond yields (and spreads) are exploding higher…

…placing ‘defragmentation’ risks squarely back on the table.

Time for Christine to bail the Italians out again?