BLACKROCK BULLETIN

Italian voters reject reform

Key views

  • An Italian caretaker government will likely be appointed. An ongoing presence of Finance Minister Pier Carlo Padoan might reassure investors.
  • The vote is unlikely to be a sustained negative for Italian government bonds, we believe, although volatility is likely ahead. We see a clean-up of Italy’s banking sector grinding on.
  • We expect any caretaker government to focus on changing Italy’s controversial 2015 electoral law before new elections are called.

 


 

Italian voters have rejected a constitutional amendment designed to alleviate political gridlock by centralising power at the expense of regions and the Senate, as predicted by polls. We see little progress ahead for reforms to streamline the country’s government and liberalise the economy, but do not expect the “no” vote to hurt Italian or Eurozone assets in the medium term.

Prime Minister Matteo Renzi vowed to resign after the result. A caretaker government would probably fill the vacuum until elections are held, but the scale of the defeat may mean it takes some time for a new government to be formed. Finance Minister Pier Carlo Padoan, an internationally respected economist, would likely play a senior role in a new government, which should help reassure investors. Renzi is likely to remain as head of the Democratic Party, the largest in Italy’s parliament, but play a low-key role until elections are held sometime between autumn 2017 and spring 2018, in our view. We see an immediate election as unlikely.

Any caretaker government will likely focus on rewriting a 2015 electoral law known as the Italicum, which grants an automatic majority to the biggest party in parliament, as well as the electoral law for the Senate. We see a reduced probability of an election before such electoral law changes are made because it would likely result in a hung parliament. That would make it harder for the populist Five Star Movement – which favours a non-binding referendum on Eurozone membership – to find an immediate pathway to power, in our view. We believe other reforms are likely to grind to a halt under a caretaker government. Once new electoral laws are passed, new elections could come as early as Q4 2017.

What it means for markets

We do not expect the “no” vote to be a sustained negative for Italian government bonds because political risk had led to a spike in yields before the referendum. The premium partly reversed before the result, however, and more volatility triggered by political developments appears likely.

Unless the no vote results in political instability, we expect the recapitalisation of Italy’s troubled banking sector to push ahead and do not see it affecting other Eurozone bank efforts to raise capital. We see some public injection of funds as more likely. This politically sensitive step would require junior bondholders – many of whom are individual investors – to take a loss.

The outcome reaffirms our preference for selected Eurozone peripheral government bonds and corporate credits such as subordinated bank debt. We have been underweight European shares but see recent euro weakness and a global reflationary environment as positives for exporters and cyclical shares.

Italy’s referendum kicks off a series of votes that will show how much anti-establishment politicians are gaining power across Europe. Elections dot the calendar in the Netherlands, France and Germany next year. Markets have started to price in political risk, most recently seen in a rise in French bond yields, and we expect more volatility ahead of these key votes.

DOWNLOAD BULLETIN