Even as Mario Monti returns from an encouraging trip rebuilding Italy’s credibility in Asia, his technocrat government recognises that the honeymoon is over at home and his toughest political challenge is about to begin.

The prime minister’s controversial labour reform plan, opposed by leftwing trade unions and the centre-left Democratic party, is expected to be finalised on Wednesday for presentation to parliament, where the survival of his unelected government depends on cross-party support.

“We had an incredible 100 days of honeymoon,” said a senior official, who asked not to be named. “People were so glad to get rid of Silvio Berlusconi and see confidence in Italy restored. But that phase is over.”

The full effect of Mr Monti’s €30bn austerity package that was passed in December is starting to be felt as tax increases kick in, exacerbated by rising petrol prices and sharp increases in household energy bills. The government’s opinion poll ratings have been dented. Its forecast for a fall of just 0.4 per cent in gross domestic product this year looks unrealistically hopeful.

Equally worrying for Mr Monti, officials and debt analysts say, is that foreign investors are not returning to buy Italian state bonds.

The sharp decline in yields this year, they say, is because of purchases by Italian banks, which are making use of cheap lending by the European Central Bank. That effect is likely to prove transient while Rome is only about a quarter of the way through this year’s financing needs of about €450bn.

And as Mr Monti warned last month, there remains the continued danger of “contagion” from Spain, where Mariano Rajoy’s government has failed to meet investors’ expectations even as Italy has exceeded them.

Confindustria, the main employers’ lobby, and its pro-market supporters urged Mr Monti on Tuesday to “show his mettle” and not bow to leftwing pressure to dilute his proposed changes to Article 18 of the workers statute – changes that would make it easier for companies to fire workers.

Public confidence in Mario Monti

As Mr Monti’s talks with Asian officials demonstrated, however, the biggest worry among investors contemplating the eurozone debt crisis is focused more on the threat of near-term political instability in Italy, rather than whether the prime minister will push through decisive labour market reforms with a more long-term influence. This could give Mr Monti some leeway to compromise over Article 18, rather than risk a split within the Democrats, the second largest party, that would destroy his broad support in parliament.

Pier Luigi Bersani, Democratic party leader, has tacked back and forth over the issue, voicing opposition to the proposals while also insisting that the Democrats would not be a hostage to the CGIL, the largest and most leftwing trade union federation, which is threatening a national strike over Article 18.

Some government insiders say Mr Monti’s focus on labour market reform might prove to be a strategic error as the issue becomes more of a political battleground than a real debate over its economic value. Mr Berlusconi’s People of Liberty, the largest force in parliament but languishing in opinion polls ahead of local elections next month, wants Mr Monti to hold his ground – and tear apart the Democrats in the process.

Should that happen, the dream scenario of foreign investors and a growing number of Italian politicians, that Mr Monti will somehow remain the head of a broad coalition after elections scheduled in a year’s time, would be dashed.

“The best thing Italy could do is to keep Monti and his government,” says Nouriel Roubini, a US economist who spent much of his childhood in Italy. At a conference in Cernobbio last weekend he told the Financial Times: “The reality is that [no investor] wants him to leave now or even after the next election.”

Additional reporting by Rachel Sanderson in Milan

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