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The attempt to form a government backed by the Five Star Movement (5SM) and the Northern League failed on Sunday and now a “neutral” government driving Italy to new elections looms, according to Paolo Pizzoli, Senior Economist at ING.

Key Quotes

“As had become clearer over the last few days, the choice of finance minister for the upcoming 5SM/League government was a potential deal breaker.”

“The failed 5SM/League attempt is likely to leave institutional scars. Both Luigi Di Maio, the leader of the 5SM, and Matteo Salvini, the leader of the Northern League, put the blame for the showdown on President Mattarella, with Di Maio even evoking impeachment. We do not believe that the procedure will actually start, but the institutional truce which has characterized the last two weeks now seems to be over.”

“The failed Conte attempt forced President Mattarella to take the initiative, resurrecting the idea of setting up a “neutral” government aimed at leading Italy to another election, possibly after having approved the next budget. Yesterday he mandated Carlo Cottarelli for the job.”

“Should he manage to obtain the parliament confidence, he would try to have the 2019 budget approved, and resign before the end of 2018, taking the country to new elections in 1Q19. Instead, should he fail to get the parliamentary confidence, he would resign and remain in office as a caretaker for ordinary business, taking the country to new elections after August. We believe the chances of the government passing the confidence vote are extremely slim, and hold an autumn vote (in September or October) as our new base case.”

“After getting the presidential approval, the Cottarelli government will be sworn in and within 10 days it will have to undergo a confidence vote in both branches of the Italian parliament.”

“It is still too early to understand where the party leaders will position themselves in view of the upcoming election. Chances are that the perceived institutional wound might induce both the Northern League and the 5SM to radicalize their electoral message, but different political possibilities remain possible.”

“We cannot rule out that European themes (notably absent from the previous campaign) might be more of a focus this time round, together with constitutional issues such as the role of the president. In this light, the constitution of a pro-euro moderate front would likely need more time to organize than that allowed by a September/October vote.”

“Against this potentially inflammable backdrop, the presence of Cottarelli as a fiscally prudent caretaker could act as a short-term guarantee to the markets. With current opinion polls (run before Sunday’s showdown) still pointing to a populist lead (with the League gaining ground over the 4 March result) the risk is that this could only be partially effective.”