With around 60% of voters opting for a “no” and nearly 70% turnout, Italians on Sunday firmly rejected a constitutional reform that would have removed power from the Senate and left the lower house as the key legislative chamber. The proposed reform was one of the flagship measures of Prime Minister Matteo Renzi, who resigned from his post shortly after the result.
The referendum result at the margin is negative for Italian and European risk assets, as Italy has lost an opportunity to make its political system leaner and more conducive to reforms. In addition, Renzi’s resignation will likely prompt greater political uncertainty that could complicate Italy’s ongoing bank recapitalization efforts.
But we should not overplay the significance of the vote. First, a “no” result was largely expected by investors, as confirmed by the muted market reaction following the vote. Second, following Renzi’s departure we expect to see a transition government tasked with changing the existing electoral law (currently inconsistent between the two legislative chambers). The new system is likely to be proportional and could facilitate the formation of grand coalition governments which leave anti-establishment parties in opposition. Third, the European Central Bank (ECB) remains in play in European sovereign markets; its monetary policy tools provide some reassurance for investors through periods of higher uncertainty.
Key risks to the baseline: Italy’s banks
The main risk to our otherwise balanced outlook is that sentiment deteriorates significantly on Italian banks, infecting other risk assets. The key near-term hurdle is the recapitalization of Monte dei Paschi; its failure would be a setback in the ongoing restructuring of the Italian banking system.
As the next step following the referendum and Renzi’s resignation, Italy’s President Sergio Mattarella this week will be conducting consultations to seek to form a government, headed by a political or technocratic figure. A new government is likely to be in place in coming weeks.
From an investment perspective, our stance remains fairly neutral on Italian sovereign bonds at current levels.
Nicola Mai is a portfolio manager and leads sovereign credit research in Europe. He is a regular contributor to the PIMCO Blog