Merkel and Letta shadowbox on 'growth' vs 'austerity'

New Italian PM Enrico Letta paid his first official visit to Germany yesterday, only hours after delivering his inaugural address to the Italian parliament. Much has been made of his strong 'pro-European' yet 'anti austerity' stance - so how would this go down with Die Kanzlerin? Here are some quotes from yesterday's press conference:

On 'growth' versus 'austerity'

Letta: "We have done our bit [on budget consolidation]…Europe has to implement growth policies."

Merkel: "We have to free ourselves from this misconception that growth and budget consolidation are opposed. Solid public finances are a precondition for growth. And growth is not only the state giving money, but it's creating conditions for small and medium enterprises to feel at home, to be able to invest and open up jobs. And for that we need structural reforms, good schools and universities, investments in research."

On national responsibility vs 'European Solidarity'

Letta: "In the past five years of crisis we did not find sufficient solutions because there was not enough Europe. This is my objective - and also that of Germany, because both our countries have a federalist vocation... If we reached these objectives [banking union, a fiscal and economic union and a political union] we could solve our domestic problems much easier."

Merkel: "We want to ensure Europe emerges from this crisis stronger than it went into it. As part of that every country must do its part."

On meeting EU targets

Letta: "How and where we will find the resources is a domestic matter. I don’t owe explanations to anyone. I’m not here to justify domestic choices... We have no intention of telling German citizens what they have to do, and we know German citizens have no intention of telling us what we have to do.”

Merkel: "Every country must complete its own tasks... [Italy] has already made significant progress on this path."

Overall, the tone of the press conference and meeting was fairly amicable and concilliatory. That said, there are clearly a number of potential flashpoints. For all the pro-European rhetoric, for Letta 'more Europe' clearly involves more financial help for Italy, be it via a bank resolution fund or debt-pooling and not more EU scrutiny of national tax and spending decisions which is the German approach - note Merkel specifically referred to the fiscal treaty as an "element of consolidation" and the ESM as "an element of solidarity".

As we've pointed out previously, Italy still faces a number of challenges - finding a way of balancing the books without money from the planned property tax (the cancellation of which was demanded by Berlusconi) and also re-starting the structural reform agenda which stalled under Monti following a promising start. Failure to achieve progress on these fronts will inevitably trigger tension with Germany.

A sign of things to come could be this comment from (German-born) Josefa Idem, Italy's new minister for Sports and Equal Opportunities who told ZDF that she "understands that the people most directly affected by the crisis and who draw a direct link with the austerity measures bear an aversion towards Mrs. Merkel."

Italian PM launches opening salvo against austerity - but where will the cash come from?

The new Italian Prime Minister Enrico Letta announced his first raft of policies in his first speech to the Italian parliament yesterday. The speech was strong on anti-austerity rhetoric but short on details of how his new approach would be funded - illustrating that ever-so-relevant dilemma in the eurozone (and elsewhere): it's easy to criticise austerity, much harder come up with alternatives. Here are the key points:

·    The government will scrap up to €6bn worth of tax rises, although Letta provided no detail about how this funding gap would be filled. Much of this move was motivated by Silvio Berlusconi’s insistence on scrapping a new housing tax which was laid out as a precondition for the formation of the grand coalition

·    Some phrases which will make German Chancellor Angela Merkel wince, such as: “We will die of fiscal rigour alone. Growth policies cannot wait any longer”, “[Europe faces] a crisis of legitimacy” and there is a need for a “United States of Europe”.

·    Letta believes Italy’s welfare system is inadequate and will look to broaden it to provide further help to women, young people and temporary workers.

·    Businesses will also receive tax incentives to hire young workers.

·    Again no details on how such policies will be funded. La Stampa reports that all in, the “Letta Agenda” could cost €20bn. He made no mention of privatisations or the sorely needed reforms to the labour and product markets to make Italy more competitive.

·    Letta did stress that Italy will meet all of its EU commitments and targets.

·    He set himself and the new government an 18 month window in which to achieve the some success in turning around the economy or “face the consequences”.

·    Promised to reform the electoral law and cut MP’s pay.

A very interesting opening salvo from Letta. In fact, not too dissimilar to French President Francois Hollande’s early comments regarding austerity – we can’t help but wonder if his enthusiasm and/or success will wane in a similar way.

One thing that is clear from the speech is the continuing power of Silvio Berlusconi (as we previously noted). La Stampa suggest up to €12bn of the cost of the ‘Letta Agenda’ actually comes from Berlusconi’s demands, while following the speech Angelino Alfano, the new Deputy PM and key Berlusconi ally, said, “I share the words of Enrico Letta’s speech from the first to the last. It is music to our ears.” Meanwhile, Berlusconi also took the opportunity to this morning ramp up his own rhetoric against austerity, calling for the new Italian government to “renegotiate its deficit commitments” with the EU.

All of this sets an interesting tone and background for Letta’s first meeting with Merkel which takes place this afternoon. As we have noted previously and at length, the key question surrounding this whole austerity debate remains, if not through cuts, then who will pay for the party? Germany and the ECB certainly aren't ready to foot the bill indefinitely and while market sentiment is positive now, it likely could not withstand a new spending spree in a country with a debt-to-GDP of 120% already. We suspect Merkel may make just that very point...