Graham Wainer: Italian election could put brakes on European recovery

The upcoming Italian general election is increasingly looking like a two horse race as Silvio Berlusconi has staged a quite amazing comeback.

Quite apart from the fact that he was forced out of office amid a storm of criminal accusations barely 14 months ago, investors are worried that his anti-austerity, tax cutting stance could have profound implications, not just for Italy but for the euro area as a whole.

A little over a year ago, a grand bargain was struck by the main European leaders and Italy to install a government of unelected professionals in order to introduce the difficult reforms so necessary in the country.

Following the stench of scandal surrounding Silvio Berlusconi, the new prime minister, Mario Monti, was greeted as a breath of fresh air.

The yields on long dated Italian bonds duly started falling and it’s fair to say that, along with the European Central Bank’s long term refinancing operations, this was the start of the fight back against the financial forces that were threatening to tear the euro area apart.

Crucially, it gave the governments of other weak European economies extra confidence to press ahead with their own reforms in the face of fierce opposition.

For sure, Monti’s reforms at home were deeply unpopular, particularly the relaxing of labour laws and the imposition of a punitive property tax.

But with a debt-to-GDP ratio second only to Greece and the broad political consensus in favour of austerity, he was given the benefit of the doubt.

Deep recession

The thing with reforms is that the pain is felt now while the benefits are in a hazy and politically unsellable place called the future. Mario Monti inherited an economy heading into recession with an unemployment rate of 8.8% and a debt to GDP ratio of 120.1%.

He goes into the election at a time when the economy is deep in recession with an unemployment rate of 11.2% and, most troublingly, a debt to GDP ratio of 126.1%.