• The impact on Europe of the UK’s vote to leave the European Union (EU) remains unclear, and other landmark events are now looming large on the political horizon. Italy’s major Constitutional referendum, scheduled for 4 December, could have a direct impact on the country’s political future. It could also have a broader impact on Europe and its ongoing process of reform.

  • The Italian Senate reform is a crucial part of this process of institutional renewal, but is also a political test for the government. A “Yes” victory - in favour of the reform - would underpin the existing coalition’s commitment to reform. Conversely, a “No” victory could trigger a period of political chaos in Italy, with some spillover effects into the rest of Europe, fuelling the rise of populist parties and slowing the process of reform in the EU as a whole.

  • Despite improving macro and micro fundamentals, political uncertainty has been a significant driver of the poor performance of European equities year to date.

  • On the fixed income side, the European Central Bank’s (ECB’s) bond purchases have supported eurozone bond markets, reducing the risk of high volatility in the European sovereign bond space, and attracting investor inflows in the process.

The implications of the constitutional referendum for Italy

The Senate reform is a key element of Italy’s wider programme of reform and is designed to reduce the budget, power and number of Senators. Such a move would mark the end of Europe’s only perfect bicameral system, where the Senate of the Republic (Senato della Repubblica) performs the same function as the Chamber of Deputies (Camera dei deputati), but does so separately.

Under the proposed reform, the new Senate would be a regional chamber with no power to bring a motion of no confidence in a government, while retaining the power to propose amendments and vote on constitutional issues.

The reform could make it easier to pass laws, improving political stability. That stability is an important - and elusive - commodity in a republic that was only formed in 1946. Over the past 70 years, Italy has experienced 63 different governments, with each one lasting an average of 13 months (Exhibit 1). Strikingly, over the same period, Germany has seen just 23 governments and the UK fewer than 20.

Italy has experienced 63 different governments, with each one lasting an average of 13 months

Exhibit 1: Governments since the birth of the Italian republic in 1946


Source: J.P. Morgan Asset Management, data as at 10 November 2016; Italian Government Official data from 14 July 1946 to November 2016.

The current coalition’s firm focus on reform

Prime Minister Matteo Renzi and his government have pursued a very ambitious programme of reform (Exhibit 2) aimed at addressing some of Italy’s entrenched structural issues, which many believe have contributed to the prolonged period of low growth in the country’s economy in recent decades. These issues include:

  • tackling ingrained public service bureaucracy and inefficiency
  • reinvigorating manufacturing activity
  • increasing labour market flexibility
  • restructuring the justice system
  • creating the right conditions for a more competitive economy.

Crucially, the reforms also included new electoral legislation based on proportional representation, but which guarantees a significant majority premium - and significantly more power - to the winning party of a general election.

Italian reforms have included employment and financial changes

Exhibit 2: Key reforms introduced by the current coalition


Source: J.P. Morgan Asset Management; data as of 10 November 2016.

The resistance to reforms in Europe

Europe’s reform journey is far from over, but the path towards popular acceptance of these reforms has been littered with obstacles, creating political turmoil in many countries (Exhibit 3).

In Spain, after a prolonged period of political impasse and two rounds of elections, a new coalition was born under the leadership of the previous Prime Minister, Mariano Rajoy, but is still finding its feet. While the new coalition is positive for the economy, ongoing teething troubles are making it harder for the government to implement reform.

In France, the social discontent created by labour market reform is stunting economic momentum, holding back the process of reform.

Populism has risen over the past 5 years in many Eurozone countries

Exhibit 3: Support of populist parties in many countries


Source: J.P. Morgan Asset Management, Guide to the Markets – Europe; national surveys; data as of 10 November 2016.

What happens if the “yes” contingent wins?

The Italian constitutional referendum is scheduled for 4 December. Under Italian law, a referendum on a constitutional topic requires no minimum quorum. Instead, the results will be based on the number of valid votes even if a majority is not reached. According to the most recent exit polls, “Yes” and “No” supporters are still neck and neck (Exhibit 4), making predictions very difficult.

A “Yes” victory could be the most market-friendly outcome—and the least worrisome. In Italy itself, it could reinforce the credibility of the current coalition and its focus on reform. In Europe, it could also emphasise the message that the union still needs reform and must continue to pursue it.

The margins are narrow for the December referendum

Exhibit 4: Recent exit polls on the Italian constitutional referendum


Source: J.P.Morgan Asset Management, based on local surveys; data as of 10 November 2016.

And what happens under a “no” vote?

The opposing scenario of a “No” vote represents more of an unknown quantity. The referendum is seen not only as a consultation on the approval of the Senate reform, but as a test for the current coalition. In the event of a small difference between “No” and “Yes” votes, the coalition could survive, but potentially with a less credible reform mandate.

However, a decisive “No” result could force PM Renzi to resign, putting a nail in the coffin of his reform agenda. Under this scenario, the President of the Italian Republic would give a mandate to a candidate in order to form a new government - a lengthy and complex process. In the worst-case scenario, where a new candidate was unable to form an agreement on a new coalition, snap elections could be called. This would likely lead to a prolonged period of uncertainty, and have a negative impact on the economy.

In addition, the political debate could cover the crucial issue of immigration and Italy’s membership of the EU, fed by the populist parties. Recent surveys indicate that Italy is one of the countries with the highest probability of a referendum on EU membership (Exhibit 5). Given Italy’s status as a founder member of the EU, and its stronger support of the political and monetary union, this seems a bit extreme.,/p>

Italy has the highest percentage of respondents wanting to leave the euro

Exhibit 5: Survey results: “do you want to leave the euro?”


Source: J.P. Morgan Asset Management, Guide to the Markets – Europe, IFOP; data as of 10 November 2016.

A “No” victory could also be seen as a test of stability for Europe ahead of important general elections in 2017, in countries including Germany, France and the Netherlands (Exhibit 6).

Political risks high this year and next, with many of the region’s largest economies holding elections

Exhibit 6: EU countries holding general elections in the coming years


Source: J.P. Morgan Asset Management, Guide to the Markets – Europe, IMF WEO April 2016, national agencies; data as of 10 November 2016.


  • December’s constitutional referendum is widely seen as one of the political events that could create most concern and volatility on markets towards the end of 2016.

  • A “Yes” victory would represent the most market-friendly outcome—and a robust endorsement of the current coalition’s ambitious programme of reform. Meanwhile, a “No” victory could have varying implications depending on the margin of difference between the “Yes” and “No” results.

  • A small difference between the “Yes” and “No” votes could see the current coalition survive, but with reduced power. Under a decisive “No” vote, the PM Renzi could be forced to resign, instigating a prolonged period of uncertainty and the possibility of snap elections.

  • The impact of the referendum result could spill over into Europe. A “Yes” victory could reinforce the importance of reforms for Europe, but a “No” result could stir up fresh social turmoil in the other European countries that are already facing a strong resistance to change ahead of important elections in 2017.

  • From an investment perspective, political events remain one of the key risks facing Europe and have driven poor performance of European equities year to date. Nevertheless, we believe there are still opportunities to invest in European equities as both macro and micro fundamentals improve.

  • For fixed income markets, the strong support of the ECB helps limit the impact of high volatility on the European sovereign bond markets. Italy is the third-largest target market for the ECB’s bond purchasing programme. Under a “No” victory and the resignation of the prime minister, a significant widening of spreads between Italian Treasury bonds (buoni del Tesoro poliennali - BTPs) vs. German bunds, as has happened in the past, seems very unlikely.

  • This is also very important for Italian banks whose portfolios are over-exposed to Italian sovereign assets and that could therefore suffer in the event of significant volatility in Italian government bonds (Exhibits 7 & 8).

Italian sovereign spread over German bunds has widened in recent weeks

Italian sovereign spread over German bunds has widened in recent weeks


Source: FactSet, J.P. Morgan Asset Management; data as of 10 November 2016.

The ECB has been purchasing primarily German and French sovereign bonds

Exhibit 8: Cumulative ECB sovereign bond purchases by country


Source: J.P. Morgan Asset Management, Guide to the Markets – Europe, ECB; data as of 10 November 2016.

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