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Forex Flash: Letta´s Italy - BBH

FXstreet.com (Barcelona) - Marc Chandler, Global Head of Currency Strategy at Brown Brothers Harriman notes that the first Right-Left coalition in Italy since 1946 has survived its first confidence motion in both chambers and as difficult as it may have been to break the political logjam, the hardwork lies ahead for PM Letta.

He comments that a new government often has a honeymoon period and there are two tells that Letta´s honeymoon will be short lived. First, initial polls show that support for him is soft and near to 40%, while in contrast when Monti took office his public support rating was a lofty 70%. Secondly, he notes that Letta wants a similar cabinet, but was forced to accept 21 ministers, rather than 12. Neither the centre-left or centre-right seems willing to accept anything that would dilute its members.

Chandler explains that this plays on concerns that although the cabinet lacks the heavy hitters and king makers in Italian politics, they are still pulling the strings from the sidelines. He writes, “The relative youthfulness of the cabinet (average age 53 years, a decade younger on average than Monti's cabinet) and the record representation by women, does not necessarily mean the old political elite have been pushed out as Renzi suggested.”

Further, he sees that Letta identified three issues that will be the initial priority of his government: halting the June payment of the unpopular IMU tax on primary residence, delay the implementation of the VAT hike planned for mid-year (22% from 21%) and end the government financing of political campaigns.

He notes that getting rid of the IMU was one Berlusconi's campaign promises, but Letta stopped short of fulfilling the promise. It appears that he has halted the June payment, but has not abolished the tax nor has he endorsed the refunding the sums previously paid. The tax may have greater symbolic value of the austerity than substance as according to a Wall Street Journal report, half of Italian households pay less than 150 euros in the IMU tax.

Further, there were a couple of other ways that Letta quickly has made it clear that despite his uncle being one of Belusconi's key advisor, he would not capitulate to all of the center-rights demands. Berlusconi wanted his ally Alfano to be the deputy prime minister and have the portfolio of the Justice Ministry. Letta granted the former but denied the latter and instead gave Alfano the interior ministry. He adds, “Berlusconi has opposed Saccomanni's advancement. Draghi had wanted Saccomanni to replace him at the helm of the Bank of Italy, but Berlucsconi blocked this and instead the position was given to Visco, who, in unorthodox fashion leapfrogged ahead of Saccomanni in the peaking order of a hierarchy that is said to rival the Catholic Church. Again Berlusconi tried to block Saccomanni's appointment in the new government, but Letta gave him the critical finance ministry.”

In some ways, with a younger cabinet, which includes some specialists with weak party affiliation, and the move away from Monti's austerity, Letta also appears to be stealing some of Grillo's thunder. Yet Chandler feels that Letta realizes that the government's stakeholders are not just the domestic forces. Shortly after he survived the vote of confidence in the Senate today, Letta went to Berlin and later this week he will visit Paris and Brussels. Additionally, he feels that Letta will not have to push very hard to get some concessions from the EU, where the EC President recently acknowledged that austerity has gone as far as it can. Italy has reduced its government debt for three consecutive years. It is one of the few countries in the euro area to run a primary budget surplus (budget position excluding debt servicing costs) and could be as high as 2.5% of GDP. He writes, “The economy is in poor shape to say the least. In fact, the severity of the economic contraction means that the Italian economy is smaller than it was a decade ago.”

He notes that the roughly 6 bln euros of revenue lost between the property tax and the VAT hike are relatively minor for the 1.2 trillion euro economy and he would not push this point too far given the large stock of Italian debt and average maturity of around, but the decline in Italian yields this month (83 bp on the 2-year note to a record low) and 88 bp on the 10-year bond to 2 1/2 year lows), if sustained will help lower the government's borrowing costs and debt servicing costs).

However, he finishes by commenting that electoral reform may be the most significant political issue for the Letta government. Ironically, delivering this could jeopardize the longevity of Letta's government. Berlusoni's center-right is running ahead in the polls and an early election would seem to benefit it. On the other hand, Renzi, who is tipped to be the next head of the center-left, is polling better than Berlusoni. However, the left is Italy is in disarray. Yet, unlike the center-right and Grillo who want Italy out of EMU, Letta knows that the future of Italy is inextricably tied to Europe.

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