Focus on fundamentals after Italy no vote

Nigel Bolton |09-Dec-2016

The ‘no’ vote results in political instability. As markets dislike uncertainty, we expect we may see a short-term spike in volatility.

What just happened?

The Italian referendum on constitutional reform on 4 December was firmly rejected by the electorate, with ‘no’ gaining 59.5% of votes cast on strong turnout. Italian Prime Minister Matteo Renzi resigned and the Italian president is seeking to form a new government with the current parliament. The reform, aimed at streamlining lawmaking in the country by weakening the Senate and making other changes, became a referendum on Renzi himself when he tied his political fate to the outcome.

What happens next politically?

Italy’s president now consults with the political parties making up the current parliamentary majority, including Renzi’s Democratic Party, to form a new government and await constitutional court rulings on electoral law in January. On Sunday, Italian Foreign Minister Paolo Gentiloni was appointed to replace Matteo Renzi as Prime Minister.

Italian banking shares and Italian government bonds rebounded last week, partly because so much bad news had been priced in heading into the referendum

Does this directly threaten Italy’s membership of the EU or the Euro?

The referendum was about changing Italy’s domestic political system and had nothing to do with EU membership. This was an entirely domestic referendum on reform of Italian domestic political processes. Having said that, anti-establishment Five Star Movement has proposed a non-binding referendum on Eurozone membership if it comes to power. Given current polls, an early election is most likely leading to a hung parliament, which is why the focus is likely to be on changing the electoral law. The next general election is due before May 2018, and Renzi’s Democratic Party currently enjoy a Parliamentary majority. Italian popular support for EU membership remains above 60%.

What is the impact on Italian banks?

A ‘yes’ win in the referendum was seen as smoothing the process of allowing some of Italy’s troubled banks to raise capital, potentially from private sector sources alone. Now some form of official support is likely. Official capital injections would require bail-ins of equity and junior bondholders, many of whom are household investors in Italy. Reports suggest the Italian government is looking at taking equity stakes by buying out some of these bondholders. Unless the no vote results in political instability, we expect the recapitalisation of Italy’s troubled banking sector to push ahead.

What is the likely impact on European
equity markets?

Markets dislike uncertainty. We expect to see political risk premium on Italian assets until the outlook becomes clearer, with the potential for market volatility. Italian banking shares and Italian government bonds rebounded last week, partly because so much bad news had been priced in heading into the referendum. We are neutral European shares but see recent euro weakness and a global reflationary environment as positives for exporters and cyclical shares.

Nigel Bolton
Head of European equities, BlackRock
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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of December 2017 and may change as subsequent conditions vary.

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