ROME Bond markets may be succeeding where political opponents have failed, pushing Prime Minister Silvio Berlusconi closer to the exit and opening up fresh uncertainties as Italy struggles to avoid financial disaster.
The spread between yields on 10-year Italian bonds over German Bunds briefly climbed past the equivalent Spanish/German spread on Friday morning, underlining the perception that Italy now poses the major threat to euro zone stability.
Berlusconi's response to the crisis, blaming international conditions and pledging unspecified measures to boost growth, has fallen flat with markets suddenly focusing on his divided government and longstanding weaknesses in the Italian economy.
"Up until a few weeks ago, it was enough to say we'll balance the budget by 2014 but now I think we need more" said Tito Boeri, an economist at Bocconi University in Milan, urging wide reforms in areas like jobs, tax policy and pensions.
"The trouble is the government is too weak to take any significant action."
Ironically, one of the Berlusconi government's main boasts, the claim to have shielded Italy from the euro zone crisis through rigorous fiscal discipline imposed by Economy Minister Giulio Tremonti, may have prevented it moving faster.
"I think a certain amount of complacency developed because they had avoided losing the confidence of the markets until recently," said Charles Jenkins, an analyst with the Economist Intelligence Unit in London.
"This complacency has now been proved wrong but unfortunately it's more difficult to regain the confidence of the markets than it would have been had something been done a few months ago," he said.
Tremonti, long seen as Italy's anchor of stability, has been damaged by a corruption investigation against a close former aide and the credibility he previously enjoyed has been eaten away by weeks of more or less open discord with Berlusconi.
The 74 year-old prime minister, already weakened by scandal, insists that the government will carry on until 2013, when new elections are scheduled.
But financial markets may show less patience than Italian voters have with a leader who has frequently enraged European partners over his handling of a crisis which now threatens the whole of the euro zone.
"The government is drifting along and we're coming up to September. They're all just trying to delay," said a senior Italian private banker who spoke on condition of anonymity. "Let's see if the markets allow it."
"The logic and the cynicism of the markets is a great ally in unblocking things and forcing people to do things they wouldn't want to do otherwise," he said.
On past occasions Italy has reached near disaster before galvanizing itself into impressive action, such in 1992 when, on the brink of a debt default, it launched an ambitious program of privatizations and fiscal consolidation.
The current crisis may actually be the catalyst the country needs to adopt the far-reaching reforms that analysts have urged for years in vain.
With bond yields currently over 6 percent and getting closer to the 7 percent level widely seen as the limit beyond which the situation risks spiraling out of control, international markets are now looking beyond the Berlusconi era.
"If a further deterioration of market conditions comes about, pressures for the prime minister to resign and accelerate the path to early elections or a technocratic government should increase substantially," UBS analysts said in a research note.
"We believe this has become a more likely outcome now."
Where that would leave Italy is unclear.
Berlusconi has said he will not stand again but it is unclear what will happen to the ruling PDL party, a political formation built entirely around the premier which will probably break up and reform as a new center-right party when he departs.
The center-left opposition has urged Berlusconi to resign and has proposed a so-called technical government of experts to steer Italy through the crisis, along the lines of the one led by Lamberto Dini, a former Bank of Italy official, in 1995.
In theory at least, such a government would be free of the need for re-election and could tackle potentially unpopular reforms such as liberalizing services or shaking up labor laws which protect those in work but discourage new hiring.
The unusual speed with which parliament passed a 48 billion euro austerity package last month shows that when it needs to, Italy's political classes can put aside squabbling to rein in public finances, but fiscal rigor no longer looks sufficient.
"The line on public finances which Tremonti has followed has been followed by finance ministers from both the center-left and center-right for years," said Boeri.
"The problem with governments in Italy is that they don't do anything about growth."