May 31, 2018 / 7:47 AM / 2 years ago

Daily Briefing: Italy - a government in sight?

LONDON (Reuters) - After declaring that new elections were the only way out of Italy's political deadlock, League party leader Matteo Salvini in the end suggested yesterday he still hoped a new government with anti-establishment 5-Star could be formed imminently.

The Italian flag waves over the Quirinal Palace in Rome, Italy May 30, 2018. REUTERS/Tony Gentile

The nub of the issue still seems to revolve around who gets the economy minister position after eurosceptic economist Paolo Savona was rejected by the president. For now, that has calmed financial markets worried that snap elections would become a de facto vote on retaining the euro. But don’t bet on any early clarity to Italy’s confusion.

Sources close to the ECB's thinking on the saga have spelt out to Reuters the bank's logic, which is essentially to let Italy get on and solve what ECB policy-makers view as a political crisis with a political solution - for now at least. Should clear signs emerge of the country's banking sector coming under stress, then that is a different matter and intervention becomes a real possibility.

Already the Italian crisis, when combined with evidence of weakening euro zone growth, has pushed out market expectations of an ECB rate hike towards the back end of next year; the other question is whether the bank can pursue its plan of winding down stimulus by the end of this one.

This morning’s flash euro zone inflation number for May is seen picking up to 1.6 percent from 1.2 percent in April: that, at least, would help the ECB argue that its plans remain on track.

Spain's parliament today starts to debate a motion of no confidence today tabled by the Socialist party against Spain's Prime Mariano Rajoy over a major graft case inside his ruling PP party.

As things stand, the opposition Socialists may struggle to win enough support in the fragmented legislature to unseat him. But all eyes are on whether the Basque region’s nationalist ruling party decide how to vote - its officials are meeting on that in the coming hours.

Meanwhile in southeast Europe, thousands have taken to the streets of Bucharest after Romania's Constitutional Court ruled the president must dismiss the country's chief anti-corruption prosecutor – heightening fears of the judiciary coming under political control.

Since Laura Codruta Kovesi took over the anti-corruption prosecuting agency DNA in 2013, conviction rates of corrupt officials have risen sharply, winning praise from Brussels. But that doesn’t please everyone and the justice minister has called for to be sacked for exceeded her authority. President Klaus Iohannis has said he wants a full explanation of the court’s ruling before acting on it.

MARKETS AT 0655 GMT

The stabilisation of Italian and euro markets more widely continued early on Thursday as signs of compromise between Italy’s President and the two main parties trying to form a government eased investor fears of an acrimonious snap election that could put euro membership at the heart of the debate.

Italian debt markets were also calmed by a relatively successful government bond auction on Thursday, where close to the top estimate of funds were raised despite the jump in borrowing costs.

On the final day of a turbulent month for Italian politics and markets, the 2-year Italian bond yield was down more than 50 basis points from Wednesday’s close – with the spread over Germany down by similar amount.

The benchmark 10-year BTP/bund spread tightened by about 30 basis points to 241 bp -  still up about half a percentage point over the past week but well off Tuesday’s peaks close to 300bp.

Euro/dollar was also bid higher first thing, just shy of $1.1690. European stock futures pointed higher again after a strong rebound there on Wednesday and on Wall St overnight, where the S&P500 climbed more than 1 percent and the Vix volatility gauge subsided back below 15 percent.

As markets take a more sober look at realistic Italian and euro zone risks after the early week panic, it’s interesting that investors appear to prefer some nuanced form of anti-establishment coalition government to a fractious snap election that puts the future of euro membership on the table – with some players now assuming a Five Star and League coalition’s most ambitious free-spending plans won’t be deliverable and some loosening of fiscal policy not unwarranted.

The latest opinion polls show support for both parties holding up and, crucially, about two thirds of Italians still supporting staying in the single currency. The fate of anti-euro Savona, vetoed by President Mattarella as the coalition’s pick for economy minister, may be the only way now to square the circle and Five Star have already urged him to stand aside.

On world markets more generally, the dash for safety from the Italian jolt and financial contagion risk ebbed further, with 10-year U.S. Treasury yields climbing again with one eye on Friday’s U.S. employment report. European markets will eye the release of flash euro zone inflation numbers for May – with Germany and French inflation reports already coming well above forecast and above the ECB’s 2 percent target.

The consensus expectation is for euro zone inflation to print at 1.6 percent, up from 1.2 percent last month, but the Germany and French readouts suggest it will come in higher. With many debating the possible need for additional ECB support for euro zone bond markets if the Italian turmoil continued, the higher inflation rate they have been craving for so long might complicate its ability to do that.

Spain's Prime Minister Mariano Rajoy arrives at the chamber to attend a debate on the motion of no confidence in Parliament in Madrid, Spain, May 31, 2018. REUTERS/Sergio Perez

Stock markets were likely to get an additional boost, meantime, from strong Chinese business survey reading for May – something which added to the strong gains in Asia bourses overnight despite a downbeat April industrial report from Japan.

G7 finance chiefs meet in Canada later, with U.S. and global trade relations likely to dominate discussions but comments on fallout from the Italian hiatus also closely watched.

— A look at the day ahead from European Economics and Politics Editor Mark John and EMEA markets editor Mike Dolan. The views expressed are their own. —

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