Italy’s “No”-vote and its consequences

In yesterday’s referendum Italy rejected the reform of the Senate with a clear majority – about 41% voted for the plan supported by the government, 59% were against. The Italians’ No comes as a crushing defeat for Prime Minister Renzi, even though the polls of the past few weeks made such an outcome increasingly likely. The political consequences of the result of the vote are likely to be considerable. During the night Prime Minister Renzi conceded defeat and announced his resignation from the post of head of government. Renzi will tender his letter of resignation to President Matarella later today. The latter must decide whether to accept the resignation, and assuming that he does, he must then nominate a new prime minister, who must then be confirmed by parliament. Renzi has already announced that he does not wish to preside over a transitional government. Possible successors for the position of prime minister are now Finance Minister Padoan, President of the Senate Grasso and Minister of Culture Franceschini.

Meanwhile the opposition is celebrating the outcome of the referendum as a vote against the government and its austerity policy. The Five Star Movement has therefore also already called for new elections, which the social democrat PD would prefer to avoid in view of the fact that according to the polls it only has a narrow lead over the eurosceptic populists. However, President Matarella is also likely to wish to ensure that the consequences of the Italians’ vote have the smallest possible impact on political stability. Formation of a technocratic transitional government is therefore also being discussed.

Should the PD avoid new elections and succeed in forming a transitional government, the latter is likely to have greatly weakened scope of action and to take care in particular to ensure its survival until the regular elections in 2018, provided that the government does not collapse before then. While there is never a good time for a political crisis, the existing environment could hardly be more unfavourable for Italy. Besides familiar problems such as inefficient administration and weak growth the country is currently struggling in particular to find a solution to the crisis in parts of the banking sector. The renewed flare-up of the refugee crisis in Italy also requires ability to act on the part of the government. Notwithstanding this, a weakened government that is nevertheless capable of independent action to solve its acute problems could still be a better option compared to allowing Italy to descend into a political vacuum until new elections are held.

The Italians’ No to the reform is likely to have both far-reaching economic effects and consequences for the market. Due to uncertainty among private households and companies the weak growth prospects could be further exacerbated. Meanwhile the markets are already likely to factor in escalation of the political situation in the prices of Italian government bonds. In this connection it is also feared that rating agency DBRS could downgrade Italy from its current rating of “AL”, causing the ECB’s collateral requirements for Italian government bonds to increase. This would on the one hand generally reduce the attractiveness of Italian bonds, and on the other hand it would create an additional burden for Italian banks – the principal creditors of the central government in Rome.

On the one hand Italy could most certainly afford rising yields. Yields are low based on a historical comparison and even with a further increase in yields the market level can still be expected to be below the coupon levels of bonds soon expiring and thus due for refinancing. Things could, on the other hand, become critical if demand from investors in the primary market were to fall off significantly due to concern about Italy. In this case there would be a threat of a liquidity squeeze, which could set off a spiral of ever-increasing yields. Here the ECB would be required to signal to the market that it would continue to purchase Italian government bonds in the secondary market in the framework of the PSPP and might also possibly react to the increased supply with a temporary increase in demand.


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