The euro is sliding amid political uncertainty in Italy

Italian government bonds, which suffered one of its most dramatic speculative attacks in years on Tuesday, found some support from local investors on Wednesday.

But if parliament fails to approve his government, a new election would be held “after August” – the most likely outcome given only the centre-left Democratic party has announced that it would vote in favour.

What changed was the willingness of 5-Star leader Luigi Di Maio and League leader Matteo Salvini to shuffle the proposed roster of government ministers amid a financial market scare. Di Maio also called for holding new parliamentary elections after the impeachment of Mattarella.

The rally followed remarks by Italian Prime Minister-designate Carlo Cottarelli on Wednesday that possibilities had emerged “for the birth of a political government”, suggesting politicians, rather than technocrats like himself, might be able to steer the country out of deadlock.

The rare move sparked fury from both parties.

Mattarella welcomed the proposal, according to his staff. League leader Matteo Salvini, who is surging in opinion polls, seemed cool on the idea but did not rule it out.

Financial markets have calmed amid increasing signs that Italy may avoid imminent elections after the president gave two populist parties time to figure out whether they can agree on an alternative to an anti-euro economy minister.

The prospect of a new vote fueled by euroskeptic outrage spooked investors who feared the election would become a vote on whether Italy should abandon the euro, with uncertain consequences for Europe’s economy.

“The Italians would still be a thorn in the side of the eurozone, but the irritation would be long and drawn out at the negotiating tables in Brussels, and markets would recover from the current heightened level of uncertainty”.

The Five Star Movement has promised to reduce taxes and roll out universal basic income for the unemployed.

Italian President Sergio Mattarella talks to the media at the Quirinal Palace in Rome, Italy, May 31, 2018.

The new government would be expected to take a strong Euroskeptic line and seek confrontation with Brussels on eurozone governance, the European Union budget, Russian Federation sanctions and migration.

The anti-establishment and populist Five Star was the biggest single party in parliament and attempted to form a coalition with right-wing populists the League.

“Quote rates and hit rates for Italian bond enquiries on Tradeweb remained robust, despite ongoing market volatility”, says Enrico Bruni, head of Europe and Asia business at Tradeweb.

This was bad for Italy in macro-economic terms as well, since the higher the borrowing costs were, the less resources would be available for implementing certain economic or social policies.

Election promises, however, can be quite different when compared to political reality.

ANALYST TAKE: “If a government can be formed that receives the stamp of approval from Mattarella and is therefore seen as not posing a threat to Italy’s place in the eurozone, then this will come as a relief to markets in the near-term”, said Craig Erlam, senior market analyst at OANDA.