In a much anticipated risk event, we saw the Italian lower house pass its budget vote today, with the opposition abstaining from voting. This was a major test of the Prime Minister's hold on his majority and while the vote passed, the vote did not in fact secure a majority for the coalition government.
The tally of 308 yea votes out of a possible 630 means that the defectors that we read about over the weekend did in fact leave Berlusconi's side. In the last confidence vote, around one month ago, Berlusconi secured 317 votes out of the 630.
What this means is we are likely going to now see a test of whether the Prime Minister can hold onto his job via a vote of confidence, or if the opposition has its way a vote of no-confidence. That will be the next stage in this saga.
The opposition believes now that the government no longer has a majority and as a result the government should be dissolved and a new coalition formed by the Italian President, if not new elections called. The idea of a caretaker government that would unite around solidarity and a non-political technocrat as its head, would have its main goal of pushing through the important reforms needed in order to ease pressure on Italian borrowing costs.
From FT: Two possible scenarios are a broader centre-right coalition led by a Berlusconi appointee, possibly cabinet undersecretary Gianni Letta, or an emergency technical government headed by Mario Monti, former European Commissioner.
Senior officials say that as matters stand it would appear that neither would have broad enough parliamentary support to form a viable government. This would plunge Italy into the uncertainty of snap elections in January, and further delays in implementing the deficit-cutting and growth-promoting measures demanded by the European Union and ECB.
With the Prime Minister not able to secure an outright majority the writing may be on the wall for his departure. We even have reports of key allies such as the minor coalition partner head Umberto Bossi, asking Berlusconi to step down.
From FT: Pressure mounted on Mr Berlusconi ahead of the vote when Umberto Bossi, leader of the Northern League - junior partner in the ruling coalition - told reporters his party was asking Mr Berlusconi to step aside.
Yields on Italian 10-year bonds hit a high of 6.74 per cent on Tuesday morning before easing slightly, after further intervention by the European Central Bank. Immediately after the vote result was announced they climbed back up to 6.71 per cent.
If Berlusconi does step down and we see the formation of a solidarity government, it should be seen as a positive for risk sentiment as it increases the likelihood that reform measures will pass the Italian Parliament. Any protracted delays in forming a new government would create uncertainty that would be negative for risk sentiment.