Berlusconi's last stand?

Update 15:50 - The vote on the 2010 budget review in the lower house of the Italian parliament has just taken place. As expected, the review was passed because opposition MPs abstained. However, the 'yes' votes were only 308, meaning that Berlusconi has effectively lost the majority in the chamber. Previous reports suggested that 311-312 MPs would vote in favour of the review. In fact, Italian Infrastructure Minister Altero Matteoli admitted, "We were expecting different numbers." After the vote, Berlusconi reportedly talked briefly to his key ally Umberto Bossi - the leader of junior coalition partner Lega Nord. Italian Economy Minister Giulio Tremonti (who skipped part of today's meeting of EU finance ministers to vote on the budget review) and Interior Minister Roberto Maroni were also present.

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And here is what we published this morning:

Open Europe has today published a note on the dramatically evolving situation in Italy, with new estimates on how much the rising bond yields could cost the Italian government and an assessment of the current political situation.

The last week has seen Italian borrowing costs consistently increase (and thus prices fall) despite purchases by the European Central Bank. This is mostly down to the political deadlock in Italy and the increasingly untenable position of Prime Minister Silvio Berlusconi. In this briefing note, Open Europe looks at the economic and political situation in Italy and how it could unfold over the coming days and weeks.

Key points:
• Berlusconi’s majority in the lower house of the Italian parliament remains uncertain;
• If Berlusconi falls, the best option for Italy and the eurozone would be a national unity government with a strong backing in the Italian parliament;
• At current borrowing costs Italy could face an extra €28bn in interest payments over the next three years, potentially wiping out almost half of the projected €60bn budget savings by 2014;
• Italy needs widespread institutional as well as economic reforms if it is to return to economic growth.

“Another decade of stagnation a major risk…Another decade of disappointing growth would make public debt difficult to sustain…Declining public bond prices would worsen banks’ and insurance companies’ balance sheets, with a possible vicious cycle.”
- IMF Staff Report on Italy, July 2011

This morning, Italian ten-year borrowing costs reached a record 6.74%, very close to the 7% threshold which financial markets see as broadly unsustainable (and which therefore often results in a self-fulfilling solvency crisis and possibly a bailout). Similar increases have been seen across the board for Italian debt of all maturities. Worryingly, short-term debt is becoming increasingly expensive (the yield curve is flattening) a sign that investors see increased risk in short term lending (something seen in the other countries which accepted bailouts).

However, rumours of Berlusconi’s resignation triggered a rebound-effect on the stock markets yesterday. There should be no doubt that, although Italy’s difficulties will not be resolved if Berlusconi goes, he is definitely a big part of the problem. So will Berlusconi resign, and what will it mean for Italy and the eurozone?

To read the full briefing click here