Analysis: Monti takes off gloves in euro zone fight

Italy's Prime Minister Mario Monti attends a news conference during his visit to Finland, at Finnish Prime Minister's official residence in Helsinki August 1, 2012.

ROME (Reuters) - Italian Prime Minister Mario Monti has taken the gloves off in his fight to save Italy from disaster in the euro zone debt crisis, daring to stand up to European paymaster Germany in a way unthinkable a few months back.

His change of attitude is driven by increasing Italian exasperation with repeated delays in formulating an effective response to a crisis on bond markets that has put Spain and Italy in the front line against an existential threat to the euro and perhaps the whole European Union.

Monti is trying to pressure German Chancellor Angela Merkel into agreeing to a European shield against high borrowing costs that are crippling Madrid and Rome and that he believes threaten the very survival of the euro if they lose access to markets.

But his outspoken tactics have already provoked a backlash in Germany and risk proving counter-productive.

The offensive partly reflects domestic pressure as Monti's popularity has slumped from above 70 percent to around 35 percent due to public anger that there has been no reward for debt-cutting sacrifices that have worsened a deep recession.

A respected economics professor fluent in French and English, the non-partisan Monti was called in last November to succeed billionaire media magnate Silvio Berlusconi as Italy tottered on the brink of a Greek-style economic meltdown.

He quietly got down to work, rarely even raising his voice, as he imposed more than 20 billion euros in painful tax hikes and spending cuts within weeks, followed by a series of measures intended to stimulate a chronically stagnant economy.

Since June, Europeans have seen a new, tougher Monti resisting perceived German lecturing that has made Merkel highly unpopular across southern Europe.

He shocked the chancellor by joining forces with Spanish premier Mariano Rajoy at a June European summit to block any agreement until the Germans accepted in principle that euro zone bailout funds could be used to contain the borrowing costs of the currency bloc's third- and fourth-biggest economies.

Although that agreement turned out to mean less than first thought, it enabled Monti to return triumphant from Brussels and head off a simmering revolt from the broad coalition of political parties that sustain him in parliament.

Under her own heavy political pressure ahead of an election next year, Merkel was unhappy with the outcome and has backed away from it since - one reason for Monti's renewed offensive.

PRESTIGE

Monti's understated, courtly demeanor and diplomatic reserve could not have been a greater contrast to Berlusconi, whose sexual and financial scandals and repeated international gaffes had accelerated the Italian crisis.

But he has become increasingly outspoken with Germany, exploiting his prestige as a respected former European commissioner widely believed in Italy to be more expert than his euro zone peers in understanding the crisis.

In what may have been a planned strategy, he spent several months building his credentials as the most "German" of Italians before exploiting that respected position with Berlin.

Monti sees his role as leading a response to the debt emergency as he works through a scorching Mediterranean summer while other leaders, including Merkel, go on holiday.

Last week, the Italian leader - who says he will take only six days off this month - held talks with euro zone hardliner Finland, key player France and fellow struggler Spain.

Monti's aim appears to be to overcome Berlin's reluctance to accept bond-buying both by the bailout funds and the European Central Bank, to which its president Mario Draghi conditionally opened the door last week.

While Berlin must wait for a decision by its Constitutional Court on the legality of the permanent rescue mechanism, Monti is pushing Merkel for a more urgent commitment to saving the euro before it is too late. German opposition parties agree.

Monti has warned that tensions inside the bloc could destroy the euro zone and expressed concern about rising anti-German and anti-European sentiment in Italy.

"He is afraid that if the markets see Europe divided, argumentative, always reluctant to pursue a clear policy, they will attack the weakest. For the moment that is Spain but Italy would be immediately behind," Sergio Romano, a former Italian ambassador and respected commentator, told Reuters.

During his Helsinki visit, Monti played one of his strongest cards, the terrifying specter for other euro zone powers of a return of Berlusconi, who has openly suggested that Italy could survive outside the euro.

"I can assure you that if the (bond yield) spread in Italy remains at these levels for some time then you are going to see a non euro-oriented, non fiscal-discipline-orientated government taking power in Italy," he said.

More pointedly, he told the German magazine Der Spiegel that Italy wanted moral support, not money, from Germany, noting Rome had not received one euro from Berlin, contrary to German perceptions. He also said Germany was the biggest beneficiary of the euro, enjoying low interest rates while Italy's soared.

But the unelected Monti's remark that governments needed to preserve room for maneuver independent of national parliaments unleashed a storm in Germany.

Alexander Dobrindt, general secretary of Bavaria's Christian Social Union, a partner in Merkel's conservative coalition, said : "Monti's greed for German taxpayer's money is awakening undemocratic tendencies."

Monti was strongly backed at home across the political spectrum with Pier Luigi Bersani, leader of the centre-left Democratic Party which tops Italian opinion polls, joining the call for more German flexibility.

"The unification of Germany was carried out with the aim of equilibrium between a big Germany and an integrated Europe... Italians and Germans should remember this," he said.

SOUTHERN EUROPEAN SPOKESMAN

Monti's emergence as unchallenged spokesman for southern Europe reflects deep and volatile anger inside Italy, where a sovereign default or voluntary departure from the euro would destroy the common currency.

At the same time, Germany is the target of increasingly hostile newspaper editorials including savage personal attacks on Merkel in the Berlusconi family's Il Giornale, most recently with the banner headline: "Fourth Reich".

That anger has boosted the populist, anti-politics Five Star Movement of comedian Beppe Grillo which is now challenging to be the second biggest party. It has also led politicians to flirt with the idea of an early election this autumn instead of next spring, although that seems unlikely.

With elections at most eight months away and Monti sticking to his vow not to run as a candidate, the uncertainty has added to market pressure on Italy, which is caught in a vicious circle of low growth, high debt and political instability.

After a period before the June summit when Monti's political support looked at risk due to the unpopularity of his economic measures, he now seems more secure, even though the politicians have obliged him to dilute many of his original reform plans.

Most of the parties seem to want to exploit Monti's prestige in the election with a widespread belief that some will try to run using either him - despite his stated reluctance - or one of his ministers as a figurehead.

Government sources say Monti front-loaded his austerity policies in the knowledge that Italy will soon enter pre-election campaigning when reforms will be difficult.

Nevertheless, he pushed 4.5 million euros ($5.6 billion) in extra spending cuts for 2012 through parliament this week.

Monti hopes his short period of government will permanently change Italian attitudes, slimming down the state, slashing tax evasion and consolidating prudent economic policies.

The government insists that Rome, which has a primary budget surplus, does not need a bailout like Greece, Ireland and Portugal, but European measures to enforce stability on bond markets to allow them to cut the debt.

Italian officials say the country's economic fundamentals warrant a divergence of its 10-year bonds against German Bunds of around 200 basis points instead of 440 at present.

Each 100 points of "spread" adds 20 billion euros a year in debt service costs, equivalent to the entire revenue raised by unpopular new housing taxes.

A senior government economic official, speaking on condition of anonymity, said soaring borrowing costs distorted normal macroeconomic mechanisms, compounding Italy's pain.

"The European Central Bank lowers its rates but our rates go up... interest rates are going up instead of down in a recession," he said. "Countries that don't need low interest rates get them and those in recession get high rates."

Officials respond angrily in private to German criticism of Italy's financial performance and reliability, pointing to Berlin's bailouts of banks holding toxic assets after the U.S. sub-prime crisis which barely touched Italy.

"We can point the finger equally. Nobody is innocent. Nobody is without sin," one official said.

(Editing by Paul Taylor)