Merkel Offers Carrot to Italy But Keeps the Stick in Reserve

(Bloomberg) -- Germany is ready to challenge any attempt by Italy’s populist government to flout European Union regulations or seek special treatment from the bloc.

Chancellor Angela Merkel was among the first to congratulate her Italian counterpart, Prime Minister Giuseppe Conte, but if necessary she is prepared to make clear to the new government in Rome that it must stick to the fiscal rules governing the euro area, according to two German government officials.

As Europe’s biggest economy, Germany loomed over the euro’s convulsions for most of the past decade as the chief champion of the debt and deficit limits that bind members of the single currency. Germany and Merkel, along with Paris and Brussels, were frequent targets of the Five Star and League campaigns during the Italian election which catapulted a populist government to power on a platform of budget-busting spending.

In her message of congratulation to Conte, a law professor with no political experience picked to head the coalition, Merkel said that she looked forward “to continuing and to further deepening our close partnership,” reminding him that “Italy and Germany have close and friendly relations in all areas -- political, economic and cultural.” As founding members of the EU, “our cooperation builds on our common European values,” she said.

Merkel and Conte will hold their first bilateral meeting at the Group of Seven summit in Canada at the end of the week. The chancellor met with European Central Bank President and former Bank of Italy Governor Mario Draghi in Berlin on Monday.

Tone It Down

Merkel, sensitive not to further stir anti-German rhetoric in Italian politics, will continue to say as little as possible in public on Italy, said one of the officials. She hopes that League leader Matteo Salvini will tone down his anti-euro and anti-German rhetoric in office, the official said.

Both German officials drew comparisons with Greece, whose left-wing Syriza-led government vowed to reverse German-led austerity restrictions when it took office in 2015, only to submit to a fresh round of belt-tightening to win new bailout funding months after Prime Minister Alexis Tsipras was sworn in. Italy, however is of a whole other dimension, they said. Both officials asked not to be named discussing internal government strategy.

The on-off formation of the euro-skeptic Italian government rattled markets last week, sending yields on the nation’s sovereign debt soaring and stirring memories of the euro crisis.

Debt Pile

As Conte’s team prepares for parliamentary confidence votes, Five Star and the League have denied that they want to leave the EU or the euro. Yet they’ve signaled they’ll proceed with a government program that calls for fiscal expansion, including tax cuts, a guaranteed “citizen’s income” for the poor and scrapping pension reform that raised the retirement age. All would challenge EU budget rules and question Italy’s ability to service its debt pile, the second-largest after Greece.

In the worst case, Merkel’s government sees the ECB as first in line to take action on Italy, and that any assistance for Italy would be strictly linked with adherence to EU treaties, one of the officials said.

“The Italian government knows our position,” Merkel’s chief spokesman, Steffen Seibert, told reporters in Berlin on Monday. “Europe has always been willing to show solidarity, but this can’t lead to a debt union.”

©2018 Bloomberg L.P.