How is this a strategic victory for the Allies? Germany has essentially destroyed Italy's warmaking potential by seizing the industrialised north. The Italian/French remnants combined with British troops may be able to pin down German troops by maintaining a presence in Italy, but that's about it right now.
Well, Germany has failed to win. They're in a superior position, but they haven't won. IOTL the Allies got kicked out of the continent but not ITTL, which counts as a strategic victory to me. Anyway, here's an update:
Chapter V: The Italian Campaign and the Capri Conference, January-December 1941.
The Germans had suffered over 350.000 casualties, more than twice as many as in the Battle of France, and required fresh reinforcements. Besides that, Italy’s limited infrastructure, the hostile terrain and autumn rains that had reduced a lot of country roads to sludge (and there were many of those since Italy was a predominantly agrarian country) had caused the army to burn through supplies much quicker. Given the current manpower and supply situation, the campaign could only be resumed until next year according to Field Marshal Von Rundstedt. Hitler replaced him as commanding officer in Italy by Erich von Manstein, a proven excellent offensive general (though with little experience in mountain warfare).
In the meantime, the Regio Esercito had 300.000 troops stationed in the colonies and so far Mussolini had kept them there because he feared Italy’s colonial subjects would revolt in the motherland’s moment of weakness. Now, however, he decided to transfer half of them to Italy since “there has to be an Italy for there to be an Italian Empire” (the decision was made easier because South Africa offered some troops for policing duties in Italy’s colonies). Besides that, the British redeployed the 10th Indian Infantry Division, the 1st South African Infantry Division, the 1st African Division (part of the King’s African Rifles), the Canadian Corps and the Australian I Corps to Italy (shortly after its redeployment it was renamed ANZAC Corps since it also controlled the New Zealand 2nd Division, along with British formations). France, in the meantime, contributed three divisions and several brigades of colonial forces and started to bring in divisions that had been forced to leave France since the occupation of Northern Italy threatened their rear. All-in-all, the size of Allied forces in Italy (including Italy’s own) swelled by 30 divisions in early 1941 (among them were also the 1st and 2nd Libyan Divisions, which would fight for Italy with distinction). The German presence, by contrast, only grew by 21 divisions. Because of the bad situation, Mussolini sacked Graziani and appointed Ugo Cavallero to replace him.
Between February 17th and February 19th 1941 the leaders of the three Stresa Powers convened to establish common war aims and to engage in coordinated political and military planning. Mussolini met with Churchill and Reynaud during the Capri Conference in his villa on the island resort to formulate their war goals and strategy. All three agreed that none of them would open up separate peace negotiations without first consulting the others. Secondly, their stated war goal would be to return Germany to its 1937 borders and that they would do so via a “soft underbelly strategy”: i.e. liberating northern Italy and thrusting to Vienna via the Ljubljana Gap and from there into southern Germany. Mussolini emphasized the issue of restoring Austrian independence and in passing mentioned that territorial expansion at Germany’s expense wouldn’t be out of place. Churchill and Reynaud didn’t disagree, but wanted to put off that decision. So far, the conference was a resounding success for Churchill and Mussolini, who got what they wanted while Reynaud’s proposals for landings in northern and/or southern France were rejected. First and foremost, however, they could talk all they wanted about their goals and strategies, but knew that without the active participation of the United States it was all a pipedream.
Most of Italy’s small industrial base was located in the industrial triangle of Milan-Turin-Genua – an area of intense machinery, automotive, aeronautical and naval production – and all of it was under German occupation (including the incomplete hulks of battleships Roma and Impero, which the Germans used as storage space). Armaments and heavy industrial production in Italy’s colonies was practically non-existent, leaving the Italian armed forces no other choice but to loan money to buy weapons and later to apply for Lend-Lease aid. Italy became a recipient when Roosevelt expanded it to all three main Allied powers in late 1941 as tensions mounted between the US and Japan. He was reluctant to supply a regime he loathed because of its blatant imperialist war of aggression against Ethiopia, its use of mustard gas in that war in contravention of the Geneva Protocol, and its fascist dictatorial regime that at first glance seemed to be a lot like Hitler’s. However, he understood that many of the similarities were cosmetic. Mussolini, for example, had distinguished himself by accepting Jewish immigrants fleeing the Nazis, which earned him the sympathy of the strong US Jewish lobby (the all-powerful Mafia, on the other hand, hated his guts because he had virtually wiped them out on Sicily with an iron fist campaign, including 11.000 arrests between 1925 and 1929).
Roosevelt ultimately thought of Hitler as the greater evil. Between 1942 and 1945, under the Lend-Lease Act, Italy received 7.000 motor cycles, 9.500 jeeps, 60.000 trucks, 360 locomotives, 2.500 aircraft, 1.000 tanks, 100.000 rifles, 25 million bullets, 750.000 tonnes of food supplies, a quarter of a million tonnes of fuel and 25 million dollars (roughly $375 million in today’s money) worth of construction materials. Britain also helped by marshalling the resources of the Empire, but Allied forces in Italy still weren’t powerful enough to defeat Germany. They could merely pin them down there. Both efforts were patch-ups rather than long term war winners. Nothing short of an American war effort would do.
Mussolini, being an ardent Italian nationalist pur sang, absolutely wanted his country to contribute to the war effort: he renegotiated Italy’s WW I debts to Britain in order to free up money to stimulate industry in southern Italy (and to a lesser extent in Italy’s colonies). The effort delivered a minor contribution to the war effort. The much larger agrarian component of Italy’s economy was far more important, supplying Allied forces with sugar, citrus, wine, olives, grains, meat (cattle, pig, sheep and goat) and seafood. Desperate for anything useful, Governor-General Italo Balbo ordered a geological survey in Libya. For a long time the suspicion had existed that Libya possessed oil reserves, but nothing had ever been undertaken to ascertain the truth. Oil would be discovered at Zaltan in Cyrenaica in 1943, but the war delayed exploitation, and it wasn’t really needed either because Britain got plenty of oil for the Allies from the Middle East where it controlled a substantial “informal empire”. The US would also supply fuel upon its entry into the war.
Holding out on continental Europe would not only stave off a German invasion attempt of Britain, but Winston Churchill also hoped to convince the US government that the war wasn’t a lost cause and tried to arouse sympathy by portraying it as a fight between the Allied David and the Axis Goliath. Churchill, out of wishful thinking, thought the United States would join the war sooner rather than later, and when that happened the Allies would use American might to push into Germany’s “soft underbelly.” The Atlantic Charter, signed on USS Augusta in August 1941, provided only a faint hope of that occurring: it detailed the goals of Anglo-American cooperation for the cause of international security, but didn’t mention anything about US entry into the war.
In the meantime, Hitler, who was unwilling to postpone his invasion of the Soviet Union for yet another year, de-intensified his effort in Italy. Hitler believed Wehrmacht would easily be able to hold the Allies at bay with a defensive effort in the Apennines and turn Italy into the “largest Allied internment camp” (much like Greece in WW I). He did launch a final offensive in the spring of 1941, moving the frontline somewhat further south. The new frontline by May 1941 went from Leghorn to Pesaro via Siena, Arezzo and the Foglio River. From now on, German forces wouldn’t do more than fight small operations to take control of good starting positions for “the final offensives of the war” that would take place once the Soviets were defeated. After the USSR was defeated, which Hitler arrogantly assumed wouldn’t take very long, the Western Allies would surely fold.