This weekend’s Italian elections are provoking a good deal of commentary and fueling mounting concern about possible consequences for the European debt crisis, and in particular for the outlook for Italian sovereign spreads in the short term. We think much of this concern is misplaced, not because we don’t think there is cause for concern, but because people are getting the timing wrong.

The most likely outcome of the elections is a Democratic Party victory, but it will be one without a sufficient majority to govern alone, especially in the Italian Senate. But in this eventuality the party will have a clear ally available for forming a government in the shape of Mario Monti.

What this basically means is that all will effectively continue just as it has been, at least for the time being. The new government is not going to initially be subject to the kind of instability we saw in the PASOK government in Greece in the months which finally led to the last round of Greek elections.

But that doesn’t mean that all is well. Italy has been a complete laggard in terms of reforms when compared even with Spain. The only substantial achievement to date has been the pension reform.

At the same time the country’s recession, instead of lessening, actually accelerated in the last three months of 2012, with GDP levels at the end of the year being similar to those first seen during the year 2000, well over a decade ago.

The country may be moving back in time, but its debt is still rising. Despite the significant fiscal effort Italy has been making under Monti’s stewardship, gross government debt had marched upwards to 127.3% of GDP at the end of the third quarter last year.

With the economy continuing to contract, and inflation weakening notably, this upward trend will continue during 2013. Unemployment is low compared with other southern European countries, still around the 11% mark. It is, however, continuing to rise, and social tensions inside Italy are mounting. If the reforms so far implemented don’t bring the desired results – and it is likely they won’t – then anger and disenchantment will only grow and grow.  This is where the inherent instability in Italian politics might well start to show itself.

Neither Silvio Berlusconi, nor the new rising star of Italian politics Beppe Grillo, will be stakeholders in the new government, so they will have nothing to lose and everything to gain from grinding down its popular support. The Democratic Party itself is in fact a coalition of ex-Communists and ex-Christian Democrats. At some point popular anger will rise to such a level that divisions within the Democratic Party will mean it can’t hold to its alliance with Mario Monti, since the political price it will be paying will be perceived as too high.  At that point new elections will become inevitable. This is the moment that all that concern should focus on.

Both Silvio Berlusconi and Beppe Grillo are extremely ambivalent about the euro.  At some point the two may jointly command a popular majority, and a pact between them –  improbable as it may seem – is not impossible. Even more important here may be the timing of the next government’s disintegration. Disillusionment with incumbent governments is growing all across the southern fringe – in Portugal, Spain and Greece.  This weeks en bloc resignation of the Bulgarian government, although an isolated event at present, could give us an idea of what could happen, not in one country, but across a group of them as contagion moves from being a financial phenomenon to becoming a political one. If this scenario were to pan out all that current market nervousness would suddenly seem like mere child’s play.