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After a week of falling prices triggered by investors’ fears of a populist, Euroskeptic government taking shape in Italy, the Italian markets recovered somewhat. But several economists think that Italy, home of the world’s fourth-largest bond market, might take another dive as the new government implements expensive programs that could blow the budget apart.

On Thursday, the day after Giuseppe Conte – a little-known civil lawyer and academic with no political experience – was named prime minister of the euro zone’s third-largest economy, the selling pressure on Italian assets eased. The yield on the benchmark 10-year bond, which had climbed to the highest level in 14 months, dropped five basis points, to 2.34 per cent (100 basis points equals one percentage point).

Still, the yield is up by 60 basis points over one month, by far the biggest increase among any of the European economies that saw their yields climb during that period.

The Milan stock exchange rose about 0.8 per cent Wednesday, but the gain did little to recover the deep losses earlier in the week. The Milan index, Europe’s best performer last year, is still down more than 4 per cent over the past month.

The lull may not last since the new government wants to implement policies that could both widen Italy’s budget deficit considerably and strain Rome’s relationship with Brussels. Megan Greene, chief economist at Manulife Asset Management, said in a note that Italian bond yields “are going only one way – up.”

The new Italian government is the first populist government in a large European economy and the first among the Group of Seven countries. The ruling coalition is formed by the two biggest winners in the March 4 election – the Five Star Movement (M5S) and the League (formerly the Northern League).

While they don’t have a lot in common, they are both anti-establishment parties bent on shaking up the traditional Italian ruling class – which billionaire luxury-products tycoon Diego Della Valle has called a “petrified forest” – and Italy’s relationship with the European Union. Both have young, untested bosses. M5S is led by Luigi Di Maio, 31, whose power base is in Italy’s poor south, where youth unemployment is almost 50 per cent. Matteo Salvini, 45, leads the League, which is strong in the industrialized north.

Mr. Conte, a 53-year-old professor at the University of Florence, may have little independent power. He is a compromise candidate and will be charged with seeing through the common platform of M5S and the League.

These policies include the rollbacks of the pension reforms that helped to spare Italy from financial calamity in 2011 and 2012, when the country came perilously close to a bailout; dropping taxes substantially and perhaps introducing a flat tax; a pro-Kremlin foreign policy shift; strong curbs on immigration and the mass expulsion of illegal immigrants.

For its part, M5S wants a guaranteed annual income for the poorest Italians, a idea that doesn’t seem to interest the League. Both parties are toying with the idea of launching a parallel currency, called a mini-BOT, a form of government IOU backed by short-term government notes. Brussels is worried that the mini-BOTs, if successful, might pave the way for Italy’s exit from the euro (at one time, both M5S and the League pledged to hold a referendum on the euro, but the idea did not make it into their official governing plan).

Investors are rattled by the new government’s economic policies because of their potential costs. In a Thursday note, Paolo Pizzoli, a senior economist at ING, said that full implementation of the economic program would push the Italian budget deficit to between 5 and 6 per cent of gross domestic product, well beyond the EU’s 3-per-cent deficit limit, “and is likely to be met with stern opposition from both the EU Commission and European partners.”

The government appointment that most concerns investors and Brussels is that of finance minister, who is expected to be Paolo Savona, a former industry minister who had stints at the Bank of Italy and as a university professor. Mr. Savona was initially enthusiastic about the euro, which was introduced 19 years ago, but has since changed his tune and now argues that the launch of the common currency was a mistake. He has not, however, argued that Italy should ditch the euro.

“Over time, he has been notably critical of the hegemonic role of Germany in the European governance since the birth of the euro,” ING’s Mr Pizzoli said. “He would surely be a technically qualified candidate but, at the same time, [deliver] a strong statement that the M5S/Lega ticket government wants to start in a challenging mood.”

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