Europe may accelerate a shift away from its austerity-first agenda this week as the new Italian government changes course and a German-Spanish investment pact underscores a renewed focus on combating record unemployment.

Yesterday's swearing in of Italian Prime Minister Enrico Letta ends a political deadlock nine weeks after voters rejected the country's budget-cutting course. German Finance Minister Wolfgang Schaeuble, a champion of austerity, will travel to Spain today to unveil a plan aimed at spurring investment in Spanish companies. Later this week, the European Central Bank may also cut interest rates at a meeting.

“You have to react to economic developments — we do so in Germany,” Schaeuble told members of Chancellor Angela Merkel's Christian Democratic Union in Berlin last week. “We are not bureaucratic; we are not stupid.”

The new Italian government's pledges to dismantle parts of the budget-cutting project undertaken by ousted premier Mario Monti opens a new front in the debate over the German-led policy of austerity to overcome the bloc's debt crisis. As the 17-member euro area remains mired in recession, European leaders are joining global critics in urging the bloc to devote more resources to boosting economic growth.

Italian bonds jumped today, with the 10-year yield falling 8 basis points to 3.98 percent. The bonds have gained for four straight weeks, with the benchmark yield reaching the lowest since 2010 last week. As the two-month political gridlock ended, speculation increased about the ECB's possible rate cut.

Letta of the Democratic Party, at 46 the third-youngest Italian leader since World War II, came into office after sealing an alliance with former premier Silvio Berlusconi and recasting the coalition that stood behind Monti.

The premier's swearing-in ceremony was marred by a shooting outside the premier's office in central Rome in which two police officers were shot by a lone gunman.

One of the first tests of the new partnership may be a property tax that three-time premier Berlusconi has vowed to eliminate. Berlusconi said this weekend that Letta had agreed to abolish the measure on first homes and reimburse last year's payment, a move he said may cost about 8 billion euros ($10.4 billion). Letta has not confirmed the agreement and his first Cabinet meeting didn't address it, according to his office.

Scrapping the unpopular tax would mark a challenge to European leaders' preference for fiscal belt tightening at a time when it has come under increased criticism for compounding economic distress. European Commission President Jose Barroso spurred a debate last week when he said that while consolidation is necessary, budget-cutting had run its course.

Policy Limits

“We are reaching the limits of the current policies,” Barroso told an audience in Brussels a week ago.

While the comments drew ire from German lawmakers in Merkel's coalition, Germany's government said that Barroso's position was in accord with Berlin and stressed that Europe must be flexible in how it responds to economic distress.

German Deputy Finance Minister Steffen Kampeter said last week that the bloc's budget rules “aren't rigid.”

Joachim Fels, co-global head of economics at Morgan Stanley in London, yesterday cited “accumulating signs that austerity is yesterday's policy, at least in Europe” as a signal of optimism about a global recovery in the second half.

Schaeuble offered the latest signal that Merkel's government is adjusting its crisis stance in comments late last week. He said he'll use today's meeting in Madrid with Spanish Economy Minister Luis de Guindos to push for an investment program that sidesteps the EU Commission.

The plan, announced on the same day that Spanish Prime Minister Mariano Rajoy said he was seeking a two-year extension to meeting EU deficit rules, could serve as a model for other countries suffering with battered economies, Schaeuble said.

“If the economy deteriorates, you don't reinforce the economic downturn through deeper cuts,” he said.

The depth of Europe's economic woes was on display last week. Unemployment in Spain rose to more than 27 percent in the first quarter, the highest since at least 1976, with more than 6 million people in the country out of work for the first time, the government in Madrid said April 25. Joblessness in the euro area as a whole stood at a record 12 percent in February.

The ECB may also pull its weight. The Frankfurt-based bank will lower its benchmark rate to a record 0.5 percent when central bankers meet on May 2 in Bratislava, according to the median of 69 economist estimates compiled by Bloomberg.

Job Cuts

To be sure, austerity measures continue in crisis-stricken euro nations. Greek lawmakers passed a bill late yesterday including plans to fire 15,000 workers by the end of next year as the government of Prime Minister Antonis Samaras cleared the latest hurdle to receiving international aid payments.

As Merkel approaches national elections in less than five months, softening her stance on indebted nations in the euro area will pose a challenge. Last week she again defended scaling back budgets.

“We always talk a lot about growth in Europe, but we have to ask ourselves what we mean by that,” she told savings banks officials in a speech in the eastern city of Dresden. “Growth only on the basis of state financing won't make us more competitive in Europe.”

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Europe Poised to Soften on Austerity

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