Italian voters declare opposition to austerity

Euro symbol made out of bread Will Germany keep signing the cheques if Rome does not toe the fiscal line?

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As one office worker succinctly put it to a reporter, the Italian election result shows that the country isn't united - and that it isn't working.

There is political deadlock in the Rome Senate, consternation in European capitals, and continued selling of Italian securities on the financial markets.

After a period of relative political and economic calm since Brussels' veteran Mario Monti was drafted into service as Italy's prime minister, it's almost certain that the inconclusive election result will herald renewed market pressure on the eurozone's third largest economy.

The conflicting and confused message just sent by voters is bound to trigger further effects beyond the initial plunge on the Milan stock market and an overnight hike in bond yields. Financial commentators are already speculating that Italy may be obliged to seek a rescue loan.

It was, after all, only the reformist policies being pursued by Mr Monti's outgoing technocratic government which were standing between Rome and unaffordable borrowing costs. The Monti reforms were also underpinning the European Central Bank's fragile grip on monetary stability throughout the currency area.

Yet, now that voters have rejected those very policies, the ECB may be forced to ride to Italy's rescue. But even this is fraught with difficulty, because the ECB can only intervene and engage in its much-vaunted "outright money transactions" if the receiving country is still pushing through a programme of reforms.

Germany would agree to nothing less. So the outcome of Italy's election is a strong signal that the eurozone debt crisis is far from over. It could also be damaging for Ireland and Portugal - the two somewhat better-behaved members of the bailout programme. Both had hoped to take the "exit" at the end of 2013.

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It seems doubtful that an economy that has hardly grown in two decades could be turned around anytime soon”

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Impatience

This election result also illustrates that the longer the hardship lasts, the more voters may be drawn to populist policies.

Some 57% of Italian voters plumped for parties that explicitly oppose austerity. It's an uncanny repeat of the similar electoral success of the anti-establishment Syriza party in Greece.

Recent history suggests people are more likely to support austerity measures, if they can start to see tangible results in return for their sacrifice. This factor also partly explains Germany's impatience with Italy. Unfortunately, the rest of the western world has been growing faster than Italy for the last 20 years or so.

Italy remains bureaucratic and highly state-regulated. It is one reason why the Five Star Party was strongly supported by the "lost generation" of younger voters who find themselves shut out of the employment market by a older, protected group of middle-aged and older workers.

It is against this background that a weak centre-left government drawing on support from unions may find it even harder to enact the kind of reforms that stand any chance of improving productivity and competitiveness.

Toeing the line

As things stand, Italy's economy is still shrinking and its debt is forecast to rise to 128% of GDP by the end of this year. Both the Silvio Berlusconi and Beppe Grillo political camps opposed some of the tax hikes and public spending cuts instituted by Mr Monti.

Yet, even if some of these cuts were reversed, it seems doubtful that an economy that has hardly grown in two decades could be turned around anytime soon. Reversing the most recent reforms would also signal that the new government was unwilling or unable to deal with fundamental economic problems.

This in itself could lead to spiralling bond yields and the flight of capital invested in Italy could resume. The Five Star Party's avowed opposition to eurozone fiscal convergence might also slow future progress on banking union and other financial reforms.

Meanwhile, in Brussels, the election outcome may further complicate relations between Rome and Chancellor Angela Merkel in Berlin. Germany will no longer sign the cheques if it cannot show its electorate that Italy is toeing the fiscal line.

For some, the only possible silver lining is that this latest popular backlash against Brussels-imposed austerity may force Germany and other EU partners to reconsider the pace of reforms.

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