Italian Political Future to Shape Euro

Mario Monti, the current Italian Prime Minister, had unexpectedly announced earlier this month that he would be resigning his position before the year’s end. Market players were obviously perplexed and concerned about this as Monti’s stable presence assuaged concerns about the Eurozone’s third largest economy. Investors fully believed that Monti would live up to his commitments to reduce the deficit and Italy’s overall debt burden.

Within what seemed like moments after Monti’s announcement, Berlusconi – who last held that office only a little more than a year ago – announced his intention to run for the vacant seat. Berlusconi is already talking up a possible Italian exit, saying that they might be forced out of the Eurozone if the central bank isn’t given additional powers (i.e. lender of last resort) which would ensure that borrowing costs are lowered. Indeed, Italy’s borrowing costs had surged initially, 10-year yields rose by 29 basis points just after Monti’s announcement, but subsequent yields have improved not because market participants are no longer concerned about Italy’s future but because the ECB stands at the ready as a backstop.

Berlusconi will be challenged for that seat by Pier Luigi Bersani, a candidate from the center-left; Bersani has said that he understands how severe the crisis that Italy is in and vowed that he would continue to abide by Monti’s pledge to adhere to fiscal reforms to reduce sovereign debt. Bersani has said that he is concerned about rising costs for sovereign debt, and especially worried about the widening spread between Germany’s debt and Italy’s. He believes continued friendly discussions with Germany are the way forward; however he also believes that France’s Hollande has the right idea and that a growth-based focus is extremely important. Recent polls show Bersani’s Democratic Party about 14 points above Berlusconi’s People of Freedom Party.

The Euro-Dollar has recently firmed, striking a multi-month high, with risk appetite whetted to some extent by the promise of a resolution to the U.S. fiscal cliff crisis. Analysts expect the pair to be range bound with the Christmas and New Year’s holidays approaching, but jitters will resume in the coming year as market players gird themselves for Italy’s Prime Minister seat show down.

Though the election won’t take place till February, many wonder which role Berlusconi will be playing if he is once again elected as Italy’s Prime Minister. Will he be Italy’s savior or the philandering, wealthy playboy? For the sake of the Eurozone and the global markets one can only hope it is the former and not the latter.