Brussels calls on Italy to stay committed to the 'European path'

Bloomberg’s Christine Harvey explains why Italy is struggling to form a coalition government

So far, market reaction has been muted in response to what some analysts described before the election as the "nightmare scenario" of a 5-Star/League government.

More than 10 weeks after inconclusive elections, the two political rivals had been expected to tell President Sergio Mattarella on Monday that they had a government deal and to reveal the identity of their pick for prime minister.

Matteo Salvini, 45, of the anti-immigrant League and 31-year-old Five Star leader Luigi Di Maio, agreed a policy platform Thursday morning, a Five Star official said. Late on Tuesday, a draft coalition programme leaked.

Italian bond yields and the cost of insuring Italy's debt against default jumped on the news even after Claudio Borghi, the League's economics chief, told Reuters the request for debt forgiveness was never in an official draft of their programme.

Italy's 10-year bond yield rose 0.06 percentage points in morning trading as investors retreated from the country's debt - yet they remained below pre-election levels, when a Five Star-League coalition was an unlikely scenario.

The opposition Democrats, who controlled the outgoing government, warn that the League's vow to drastically lower taxes to a flat 15-percent rate, and the 5-Star's promise to give government subsidies to low-income Italians will spook financial markets and drastically drive up government borrowing costs.

The debt wipe would cut 10 percent off Italy's debt/GDP ratio but the European Union will be concerned this sends a negative message to other Eurozone countries still in the middle of tough austerity measures. It would make "a mockery" of the eurozone's fiscal rules, whereby the government must keep a tight lid on its budget deficit to start tackling its unsustainable debt pile of 130% of GDP. Salvini dismissed concerns about the widening gap, or spread, between Italy's benchmark bonds and safer German ones as a sign the two potential partners were on the right track.

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And he told the educators they have his support. "So when we say an average salary is $51,000, that doesn't reflect the base pay". It's inspiring. "They came today because they believe they deserve the legislature's respect for helping to make that happen".

With neither Di Maio nor Salvini willing to cede the premiership to the other, they need to find someone else palatable to both of them whom Mattarella could tap to form the next government.

Coalition negotiations are aimed at "giving a government of change to this country", Di Maio said, insisting on more time to achieve a deal so the coalition could last the five full years of Parliament's term. But when the next downturn arrives, "the political chemistry in Italy will be entirely different from the crisis of 2011 to 2014" - and not in a way that bodes well for European integration. "The European Union would not be complete without the Italian nation", Juncker said.

The issue lay dormant during this year's election campaign as both parties continued to shy away from aggressive stances on the single currency, fearing it could scare voters. Berlusconi, 81, has warned the 5-Stars are risky for Italy and its democracy. Italy is the euro zone's third-largest economy.

Salvini taunted Brussels by warning that if European Union capitals were concerned, "then we're doing something right".

Each party plans to consult its supporters over the weekend to see if they back the possible pact for government.

Di Maio said earlier Thursday that the final version of the contract would be put to his party's members for approval "probably tomorrow".

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