Yesterday, the push to form a populist government derailed, after President Sergio Mattarella vetoed the Five Star/League choice of euro-sceptic finance minister Paolo Savona, citing concerns about threats to Italy's euro membership and the savings of Italian families. Five Star and the League reacted furiously to the decision, accusing the President of being influenced by Moody's decision on Friday to put Italy on negative watch.
The ball is now with the President again. He has indicated that he might take a few days to consider the request to dissolve parliament and call for new elections. At the time of writing, Mattarella has just given former IMF official Carlo Cottarelli the mandate to try to put together a 'neutral' interim government.
There is heightened uncertainty about what will happen next but we think current developments point to Italy heading to the polls again eventually. The President seems reluctant to call a vote before the 2019 budget is approved in October, preferring an interim government that would last until the end of this year and take the country to new elections in early 2019. However, given opposition from Five Star, the League and Forza Italia, such a technocratic government currently looks unlikely to pass a vote of confidence. This makes new elections in the autumn the more likely option in our view (9 September mentioned as a possible date by Italian media). This said, the power to dissolve parliament and thereby the timing of elections lies with the President (once parliament is dissolved, a vote has to happen within 70 days).
Following the standoff regarding the finance minister appointment, Five Star has also called for impeachment of the President. At this stage, we view this as unlikely, as Five Star would need the support of the League as well, which has so far remained silent on the matter. It would also risk paving the way for an additional institutional crisis, with a potential voter backlash.
Although the President's move has created some short-term respite in the Italian turmoil, we see a strong possibility that populists would emerge from a new election even stronger given the current momentum and mood. This means further market turbulence lies ahead, also because euro-sceptic tones are likely to feature even more prominently in the next election campaign, especially from the League.
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