Molto Mario?

The Teflon coating finally chipped off Silvio Berlusconi Saturday, when he resigned as Italy’s prime minister after Parliament passed the 2012 budget. Taking his place is Mario Monti, whom President Giorgio Napolitano named “senator for life” last Wednesday and asked to form a new government Saturday.

Signor Monti is a former EU commissioner with no political party affiliations and a reputation as a free marketeer. He’s rounding up a new “technocratic” cabinet, consisting of “experts” rather than politicians, and the new government is expected to be sworn in this week (pending a confidence vote in Parliament).

EU officials largely applauded the appointment but were quick to say the new government doesn’t mean Italy’s out of the woods. Indeed. Monday’s auction on five-year debt saw euro-era record-high yields of 6.29%, at coverage of 1.47x—compared to October’s 5.3% yields and lower demand (1.3x coverage). Monday’s yields are below the 7+% rates seen in secondary markets last week, but not by much.

Booting incumbent governments in other PIIGS has thus far proven a positive step to restoring some investor confidence. Longer term though, Italy needs to follow through with reforms to boost growth and reduce outstanding debt in order to stay competitive. That’s the new government’s primary task. Monti is expected to take on labor reforms, more state asset sales and other pro-growth measures—some of which are already in the just-passed budget—and he’s said to be considering real estate and wealth taxes.

How much impact the new prime minister can have is uncertain, given his government will be subject to parliamentary confidence votes and all reforms will need to pass both houses. Early elections are also possible (Italians aren’t scheduled to go to the polls until 2013). For now, Berlusconi’s People of Freedom Party has said it supports Monti, but it still has a majority in the Senate and plurality (including Berlusconi himself) in the lower house—and hence at least some veto power. Rumor has it Berlusconi threatened to “pull the plug” on Monti if the austerity measures he proposes are too far from those contained in the “letter of intent” Berlusconi presented at October’s EU summit. And his former coalition partner, the Northern League, has said it won’t issue Monti “a blank check.”

Thus, political wrangling likely continues in Italy—and with it, volatility. However, all involved still seem to agree tougher measures are needed, and Monti appears more committed than Berlusconi was—an important first step.