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The Faint Tinkling of Distant Alarm Bells

Silvio Berlusconi thought he'd surprise Mario Monti, when first he suddenly announced his willingness to run in the election and then let his party (PDL) follow that up with the threat to leave the uneasy technocratic crisis coalition. Monti however enjoys the support of the center-left PD led by former communist Pier Luigi Bersani, a party that appears curiously undamaged by its participation in the austerity coalition and looks set to take the lead in the election.

As it happens, the interests of Berlusconi and his party coincide: the former wants to be ensconced in the safety of parliament in order to escape criminal prosecution, the latter is fearing for its very political survival. How to ensure a maximum of leverage? Evidently the PDL feels its best chances lie in distancing itself from Monti and his unpopular austerity policies. This however requires some doing, given that it has been part of the coalition to date.

Monti in turn apparently wasn't going to let anyone surprise him. He likely already had a Plan B, as he has now managed to surprise Berlusconi right back by announcing that he will resign as soon as the new budget is passed. This threatens to tighten the election time table – the election may now well take place a month earlier than originally anticipated.

All this sudden activity in Italy, combined with Berlusconi's anti-austerity platform, has managed to spread a smattering of alarm in Brussels. The usual suspects had to interrupt their peace prize celebrations to let the appropriate admonitions sail forth from distant Oslo. Even Louis "Spain needs no bailout at all" de Guindos briefly awoke from hibernation to announce that Italy's imminent dalliance with democracy gives him the willies.

Reuters reports:

“European partners urged the next Italian government on Monday to stick to Prime Minister Mario Monti's reform agenda, after his decision to resign early and Silvio Berlusconi's return to frontline politics rattled financial markets.

Monti's surprise weekend announcement that he would quit because Berlusconi's People of Freedom (PDL) party had withdrawn its support for his technocrat government pushed up Italy's borrowing costs and prompted a stock market sell-off.

The campaign for an election expected in February is likely to be fought over Monti's reform agenda which Berlusconi, his predecessor as prime minister, said had condemned Italy to recession and forced him reluctantly to run for a fifth term.

By contrast European politicians and officials warned that Monti's policies must continue to prevent a return of the crisis which brought him to power a year ago, when he was charged with rescuing the euro zone's third biggest economy from the threat of a Greek-style collapse.

"Monti was a great prime minister of Italy and I hope that the policies he put in place will continue after the elections," European Council President Herman Van Rompuy said in Oslo, where he was part of a European Union delegation receiving the Nobel Peace Prize.

The comments echoed similar remarks in the past two days from policymakers ranging from French Foreign Minister Laurent Fabius to the head of the European bailout fund Klaus Regling and European Commission President Jose Manuel Barroso.

With Rome's European allies doing little to conceal dismay at the thought of Berlusconi's return – on a day when his trial on sex charges was also back in the headlines – the billionaire former premier called the EU sniping at him an insult to Italy.

Spanish Economy Minister Luis de Guindos warned that instability there could spill over and put Spain's fragile public finances at risk of further turmoil.

Attention is now focused on whether Monti will enter politics himself, either as a candidate or by endorsing one of the centrist forces that have backed his reforms and made more or less explicit pleas for him to run.

The daily La Repubblica quoted the 69-year-old former European Commissioner as saying that he had not yet made up his mind but was worried by the situation. "I don't know," he was quoted as saying. "If I had to … describe my feelings today, I would say that I am very concerned."

(emphasis added)

At the moment it actually doesn't look very likely that Berlusconi can achieve anything more than getting a solid voting block in parliament if he's lucky – which would be good enough to protect him and his personal interests. The markets are therefore still only marginally concerned, even though the occasion was used as an excuse for some selling in Italian debt and stocks.



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Italy's 10 year government bond yield keeps rising after Monti surprisingly announces his early resignation.


The MIB Index in Milan got whacked from what is its second lower high in succession, but remains within the area of consolidation it has inhabited since September. It is too early to judge whether anything meaningful will develop from here and in which direction things will ultimately head. The index is bound by resistance in the 16,500 to 17,000 area and support at about 14,500 to 15,000. As long as neither level is violated, all options remain open (see also our recent update on the EuroStoxx index, which continues to hover just below the resistance level we pointed out last week).



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The MIB has sold off a little on the growing political uncertainty as well, but remains well within its recent area of consolidation.


Judging from this relatively muted market reaction there is as of yet little reason to worry. However, we can understand why the eurocrats might be getting cold feet. For one thing, as unpredictable as Berlusconi is, he is a wily political operator who has pulled many a rabbit out of his hat in the course of his career. It would certainly not do to underestimate him. And there is another problem, even though the press is passing over it with silence: the established parties are all in trouble. There is e.g. Beppe Grillo's Five Star movement waiting in the wings. As of yet it is not known how it will do in an actual election, but if it does as well as some polls have suggested, then it is by no means certain that business as usual will continue without a hitch after the election.

Economy Remains in Bad Shape

What complicates things further are two factors: For one ting, Bersani may well win a majority in the lower house, but it is doubted that he will be able to control the senate. Thus there likely won't be a stable government. For another, here is what awaits the winner:

“Whoever wins will have to confront a severe recession, record unemployment and a ballooning public debt expected to surpass 126 percent of gross domestic product this year.

The depth of the crisis was underlined on Monday, with data showing GDP shrinking 2.4 percent in the third quarter and industrial production dropping 1.1 percent in October.”

Bersani says he will stick with the austerity and reform measures and wants Monti to play a role in his government. Perhaps he can actually make it work, given that he is close to the trade unions (on the theory that this closeness means he will be given some slack by them). The problem is that the measures introduced by Monti don't go nearly far enough in terms of economic reform and have been larded with way too many tax increases. The debtberg keeps growing and the economy is evidently still reeling. The statism-tilted gradualism preferred by the political elites everywhere in Europe is simply a case of "too little too late and way too many of the wrong things to boot".

The markets are still fairly sanguine, but it won't take a great many missteps to change that again. After all, they're levitating on little more than the thin gruel of verbal ECB intervention. In the context of Italy consider a longer term chart of the MIB, which looks quite dire indeed and puts things into perspective; at its peak the index traded at over 44,000 points.



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The MIB remains a long way from the happy days of yore. What little progress there has been depends on the other Mario in Frankfurt, whose promises are so far mainly of the virtual kind.


Conclusion: A Headache-in-Waiting

Italy harbors great potential to be reincarnated as a major headache in 2013. For now accelerating growth in the euro area's true money supply is the one factor we continue to see as the greatest source of support for the markets – as of October, the year-on-year growth in euro area TMS has accelerated to 6.1% year-on-year, the highest annual growth rate since mid 2010 (when it was decelerating; data via Michael Pollaro). However, even while it lends support to asset prices, money supply growth undermines the real economy by distorting price signals. Moreover, it is lately owed to an expansion in uncovered money substitutes by private banks, which has been egged on by the ECB's inflationary push in late 2011 and early 2012. As such it is a trend that may or may not persist and seems highly dependent on what is at best fragile sentiment.

Charts by: BigCharts

Source: Monti Plays Hardball