With a high level of turnout (68%) and a huge gap in favour of the NO supporters (60% against 40%) Italy has rejected Constitutional reform. As a result the Prime Minister Matto Renzi announced the intention to resign opening a period of political uncertainty.
The No vote did not come as a surprise and was already broadly priced into markets.
However, we may still see volatility given the uncertainty over what happens next - and over the broader political implications of the result.
Beyond the immediate market reaction, there may be broader consequences for Italy’s financial system, and for the country’s banks in particular.
The result also represents another sign of the anti-establishment sentiment that has dominated the political landscape this year - a concern given the busy European election calendar in 2017.
Back to political impasse
Structural issues in Italy have contributed to a prolonged period of low growth and declining competitiveness in recent decades. The prime minister, Matteo Renzi, and his government have pursued a very ambitious programme of reform aimed at addressing some of these issues - of which the Senate reform that has been voted down in the referendum was a crucial part. The referendum was therefore seen as a political test for the government - and the No victory was considered a vote of no confidence, that put at risk the survival of the current coalition.
It is still early to make predictions about the consequences of the dismissal of the PM Renzi. The experience of this reformist government is over showing the high resistance of people to changes and the suspicion versus the political establishment.
However, it seems still difficult, that the country could call a snap election, given that political parties will now need to re-examine the electoral law as an indirect effect of the rejection of Senate reform. The most likely outcome is therefore that the President of the Italian Republic will give a mandate to a candidate to form a new government, a very lengthy and complex process with a prolonged period of uncertainty, with negative implications for the Italian economy.
Expected result - but uncertainty lies ahead
Markets were pricing in the No result, with the Italian government bond spread over the German Bund widening in the run up to the referendum (Exhibit 1). However, we can still expect volatility in the near term given the uncertainty over Italy’s political future. In the long term, the implications for European bond markets will depend on the entity and duration of the political crisis, although the European Central Bank’s (ECB’s) bond purchase programme could potentially reduce the risk of extreme volatility.
In the weeks before the referendum, the spread between 10-year Italian and German sovereign bond yields widened, meaning markets were already pricing in the No result.
Exhibit 1 – Italian and Spanish 10-year sovereign bond yields vs. 10-year Bund
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