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Berlusconi departure 'essential to stabilise Italy'

Rumours fly that Silvio Berlusconi’s tenure as prime minister of Italy is coming to an end, and it seems likely that only his resignation can restore market confidence

Italian bond yields have surged to new euro-era highs, with the 10-year yield more than 6.5% and the two-year yield coming close to 6%. With speculation over Silvio Berlusconi’s continued premiership of Italy intensifying, the prime minister is seen by the markets as a barrier to financial stability in Italy. “Even with ECB intervention, it doesn’t seem to be stopping the rot,” says Daniel Baker, head of FX and fixed income for Europe and emerging markets at Informa Global Markets. "A 650 basis points yield on the 10-year bond was seen as a key figure and it has been broken."

Fears regarding Italy’s debt situation are not a new phenomenon – the country has been a target of much speculation since the eurozone crisis began. However, what has become apparent is that investors are more concerned by Italy’s leadership than its economic fundamentals.

Whatever the truth of the situation, it seems certain that only Berlusconi’s departure will satisfy investors that Italy is on the path to recovery.

“We either need the current parties to come together or someone who is perceived as being credible by the market,” says Baker.

As bond yields increase, concerns regarding the sustainability of the Italian debt are intensifying. Fortunately for Italy, the coupon on its bonds is relatively manageable – meaning a lack of sustainability is a long-term rather than immediate issue.

“Given the size of Italian debt, its coupons that you need to worry about, and their only averaging around 4.4,” says Marc Ostwald, financial market strategist at Monument Securities. "The yields are sustainable in the short term, but not in the long term."

If the markets’ lack of faith in Berlusconi needed illustrating, it came today: rumours of Berlusconi’s possible resignation caused the Milan bourse to surge. Stocks were up more than 2.3% in the early afternoon, after opening with a fall of around 1.5%.

“Rumours that Berlusconi would step down made the Italian bourse jump,” says Baker. "He’s seen as a big sticking point on austerity measures that are perceived as necessary."

Speculation as to possible successors for Berlusconi has been rife, with two commonly suggested candidates being finance minister Giulio Tremonti and former European Commissioner Mario Monti. However, Berlusconi has since said in a statement that any rumours of a resignation are "ungrounded."

“Across the eurozone, the market is putting a lot more credibility in the European finance ministers, like Tremonti,” says Baker. "Monti is also looked at favourably. Markets are interested in people with experience in severe budget situations, and those who are perceived as being willing to do what is necessary and aren’t acting for political gain."

Ostwald suggests that there are three possible options for Italy should Berlusconi resign. The first, and least desirable option, would be a short-term caretaker government before national elections. Such a government would lack the capacity to institute reforms that have been long-promised by the Berlusconi government. Given that much of the current loss of confidence stems from Berlusconi’s perceived unwillingness to institute these reforms, further delay does not seem desirable.

The second option would be a technocratic government – such a proposal is often linked to suggestions that Monti should head up the government – with delayed elections. Ostwald suggests that this would offer some relief, but would again necessitate near-term elections that could dampen momentum.

The most desirable option – according to Ostwald – is also the least likely: a government of national unity. One need only look at Greek prime minister George Papandreou’s struggles to form a coalition to understand why the chances of this are so slim.

It seems that Berlusconi’s departure is a necessary, but not sufficient, factor in the restoration of market confidence and financial stability to Italy.

“This pressure will carry on as long as Berlusconi stays,” says Ostwald. "Berlusconi going isn’t a panacea, but it is a step in the right direction."

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