Italy was edging towards the formation of a populist, Eurosceptic government on Thursday after the Five Star Movement and the hard-Right League said they were making good progress in talks.
If a deal can be reached, it will mark the first time that a founding member of the European project is led by populist, anti-EU forces.
“Italy will become a sort of laboratory of populism, capable of alarming our neighbours and allies,” the daily La Repubblica said in a front page editorial.
The breakthrough between the parties came as Italy’s president warned that the EU edifice is “shaking”.
Negotiations were due to continue over the weekend and a new government could be announced on Monday.
If the parties can forge an alliance, they would present a big challenge to the EU just as its energies are focused on Brexit.
The League wants to ditch the euro as Italy’s currency and both parties have blamed Brussels for economic pain caused by austerity policies and for not doing enough to help with the migrant crisis in the Mediterranean.
Italian politics has been paralysed since an inconclusive general election on March 4 gave Five Star 32 per cent of the vote and a centre-Right coalition that included The League 37 per cent – not enough for either of them to govern outright.
A deal between Five Star and The League had been hampered by the latter’s refusal to ditch their ally Silvio Berlusconi and his Forza Italia party.
Five Star refused to be part of any government that included Mr Berlusconi but The League refused to abandon him.
That impediment melted away on Wednesday when Mr Berlusconi said he would no longer stand in the way of a coalition government between the two parties.
Luigi Di Maio, the youthful head of Five Star, and Matteo Salvini, the leader of The League, held talks in Rome about forming a new government.
"Significant steps forward have been made on the composition of the government and the nomination of a prime minister,” the party leaders said.
With the two leaders unable to decide which of them should be prime minister, there was speculation that they might give the position to a third person – possibly Giancarlo Giorgetti, a senior League MP, or Giulia Bongiorno, 52, a League senator and a lawyer who defended Amanda Knox’s boyfriend from charges of murdering and raping British student Meredith Kercher in Perugia, Umbria, in 2007.
If picked, she would be Italy’s first woman prime minister.
The prospect of a Five Star-League government will be of deep concern to the financial markets as well as Brussels.
Promises of a minimum income for millions of people and much lower income tax rates would weigh heavily on Italy’s strained finances and could provoke a confrontation with the EU over spending restrictions.
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Both parties want to repeal a 2011 pension reform which raised the age of retirement – a move that economists warn could cost €20 billion a year.
While Five Star has edged back from an earlier promise to hold a referendum on ditching the euro, The League remains hostile to the currency and wants to abandon it as soon as possible.
The parties could also clash with Brussels over sanctions against Russia. Both parties want the sanctions lifted, arguing that they hurt Italian businesses that export to Russia.
The new government, if formed, could be short-lived.
The League, formerly known as The Northern League, draws its support from the wealthy north of Italy and has for years disparaged the “Mezzogiorno”, as the south is known.
Five Star, on the other hand, is popular in the south and Mr Di Maio comes from a town outside Naples.
“The two parties have never worked together before and the Five Star Movement has never been in government,” said analyst Wolfango Piccoli from the risk consultancy firm Teneo Intelligence.
“The lack of familiarity and government experience, together with the likely limited life-span of the coalition government, will somewhat constrain the capacity of the new executive to follow through on their more outlandish electoral pledges.”
Ambrose IMF Italy
With the populist parties seemingly on the verge of taking power, Italy’s president warned that the EU was facing unprecedented challenges but that European integration should continue.
The European edifice is “shaking” and needs urgent maintenance, Sergio Mattarella told a conference outside Florence.
“The European project has lost its ability to meet the expectations of large portions of the population,” the president said.
But he also said it was folly to imagine that Europe’s problems could be dealt with at “only the national level”.
“We must resist the hegemony of a nationalist narrative which offers solutions that are as seductive as they are unworkable,” Mr Mattarella said.
“Everyone knows that none of the big challenges to which our continent is exposed today can be tackled by just one member state.”
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