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Italian Political Turmoil Provides a Reminder of Economic Pain

Italian Political Turmoil Provides a Reminder of Economic Woes

(Bloomberg) --

Italy’s descent into renewed political turmoil is a reminder to investors of the country’s growth woes.

The euro area’s third-largest economy appears to be heading for early elections as soon as October after Deputy Prime Minister Matteo Salvini withdrew support from the coalition government. This could overshadow the complex negotiations for next year’s budget and shelve any serious discussion about the reforms Italy desperately needs. The economy has expanded for only one of the last five quarters.

Italian Political Turmoil Provides a Reminder of Economic Pain

The outlook for the second half of the year suggests a slow pickup is on the cards, but everything from a renewed clash with Brussels to a trade war between the European Union and the U.S. could scupper the recovery.

Against this lackluster background, Italy’s economy does show some signs of vitality. The outgoing populist government, which introduced a limited income support measure for the poor and lowered the pension age, has taken comfort in the decline of unemployment, which fell below 10% in May for the first time since 2012. Yet the country’s youngsters are struggling to benefit.

Italian Political Turmoil Provides a Reminder of Economic Pain

If League leader Salvini comes out on top after early elections, as the latest polls suggest, he will try to introduce the drastic tax cuts and new investments he has promised his voters. This will be difficult to square with the EU’s 3% deficit limit, especially if he simultaneously tries to offset an automatic VAT increase scheduled for 2020.

Italian Political Turmoil Provides a Reminder of Economic Pain

A new clash with Brussels would be a sideshow though if investors reprice the risk posed by Italy’s public debt, currently at 132% of GDP and with no sign of diminishing anytime soon.

The potential government collapse already pushed the spread between Italian and German bonds to the widest in six weeks. Still, the prospect of further easing by the European Central Bank should keep a lid on yields and Fitch Ratings on Friday affirmed the country’s credit rating.

Italian Political Turmoil Provides a Reminder of Economic Pain

A new Salvini government might also toy with the idea of reviving the mini-bills that spooked investors earlier this year. Ostensibly designed to speed the payment of government arrears, for some they could also be the precursor to a parallel currency. Compounding these fears is the fact that several prominent League lawmakers are vocal euroskeptics advocating Italy’s exit from the euro.

Most of them have moderated their public views for now -- perhaps because Italians’ support for the single currency is strong and growing. But a League-led government, trying to deliver on its spending promises, may at some point have to decide whether it’s ready to pay the price to remain in the euro.

Italian Political Turmoil Provides a Reminder of Economic Pain

--With assistance from Gregory Viscusi.

To contact the reporters on this story: Alessandro Speciale in Rome at aspeciale@bloomberg.net;Zoe Schneeweiss in London at zschneeweiss@bloomberg.net

To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Lucy Meakin, David Goodman

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