Silvio Berlusconi's political ambush of Italian Prime Minister Mario Monti's technocrat government has rattled the country's bond market, threatening to push the euro zone's third-largest economy back to the forefront of the debt crisis.
Italian bond yields jumped sharply on Monday, rising 21 basis points to 4.73 per cent and Italian stocks sunk, two days after Mr. Monti said he intended to resign, declaring he had received a "categorical judgment of no confidence" from Mr. Berlusconi's centre-right party, People of Freedom (PdL), which still has the biggest representation in parliament.
Earlier Saturday, Mr. Berlusconi, Italy's three-time premier, said he would fight another election even though he had declared himself out of the running only a few months ago and seemed set to retire from politics. The election, which had been scheduled for the spring, when Mr. Monti said he would step down, will now likely be held in February, after a crucial Christmas budget vote that the PdL has said it would not oppose.
Mr. Berlusconi said he was reluctantly campaigning again because Mr. Monti's austerity measures, while somewhat reassuring the markets, had brought Italy to "the edge of the abyss," deepening Italy's recession. Italy gross domestic product is expected to fall by 2.3 per cent this year – the euro zone's worst performance, save Greece's.
Italian bond yields rose late last week on speculation that Mr. Berlusconi, 76, was on the verge of withdrawing his support for Mr. Monti, who replaced Mr. Berlusconi a year ago, shortly after Italian bond yields breached 7 per cent. Yields that high are considered fatal; Greece, Ireland and Portugal negotiated sovereign bailouts shortly after their bond yields went beyond that level.
Only a week ago, Mr. Monti, citing plunging bond yields, had boasted that Italian finances were in much better shape than they were when he took office. On Dec. 3, the spread between benchmark 10-year Italian bonds and equivalent German bonds dipped below 300 basis points (100 basis points equals one percentage point) for the first time since March. "We are at a level which is not acceptable," Mr. Monti said, "but it's nice to see a decreasing line."
The good news did not last long. The yields reversed course later in the week, when Mr. Berlusconi's party partly withdrew support on two confidence votes on new economic measures. On Friday, Italian yields rose, sending the spread over German bonds soaring to more than 320 basis points, apparently shattering Mr. Monti's goal of leaving office with yields at fully half the level they were when he became prime minister on Nov. 16, 2011.
The yield reversal comes at a bad time for Italy, which is battling to repair its finances and economy and trigger job growth. Unless progress is made, Italy faces another ratings downgrade. On Friday, Standard & Poor's said it expected the economy to contract again next year, before returning to weak growth of no more than 1 per cent in 2014. S&P has a negative outlook on Italian debt. "We note, in particular, the uncertainty around whether the next government coalition would remain committed to the structural reform agenda initiated by the current government," it said.
Mr. Monti's premature resignation is bound to disappoint German chancellor Angela Merkel, the International Monetary Fund (which is monitoring Italy's austerity programs) and the European Commission. Their fear is that the next government will lose its appetite for austerity, pushing up Italian bond yields and risking another bout of contagion will that infect Spain, whose bond yields are higher than Italy's and which may be on the verge of a sovereign bailout.
The PdL is trailing in the polls against main rival Pier Luigi Bersani's centre-left Democratic party and comedian Beppe Grillo's Five-Star movement (Mr. Grillo calls Mr. Monti Rigor Montis). But Mr. Berlusconi is considered a savvy campaigner, and has the ability to control his message because he controls the country's biggest commercial broadcasting networks.
Some Italians think he could become prime minister for a fourth term even though he was he has been besieged by criminal trials, one of which, in October, resulted in a fraud conviction that he is appealing. In a separate trial, he is battling charges that he had sex with an underage prostitute.
While Mr. Monti always vowed to resign by the spring, he clearly does not relish the potential return to power of Mr. Berlusconi, whose lack of reforms during his long reign made the austerity programs necessary. On Saturday, in a thinly veiled reference to Mr. Berlusconi's last government, he warned that Italy risked becoming, once again, "the detonator that could blow up the euro zone."