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What Investors Should Know About the Italian Referendum
Sunday’s vote could plunge Italy’s already-troubled banking sector into further turmoil as populism continues its charge through Europe.
On Sunday, December 4, Italians will head to the voting booths in the next political drama to put investors on edge, following the populist votes to put Donald Trump in the White House and to take the U.K. out of the European Union.
Voters will cast their ballots for or against a referendum that consists of a constitutional reform that would strengthen the central government over local authorities and overhaul Italys legislature by shrinking the size of the Senate and stripping it of much of its power. Prime Minister Matteo Renzi contends these are necessary measures for overcoming political gridlock and would help pass crucial economic reforms in the euro zones third-largest economy and most indebted nation. Although theres been lively debate over the merits of the reform package, for many Italians the referendum is really a vote of confidence in the Renzi administration: The prime minister has pledged to resign if he doesnt get his way. Renzi has backtracked somewhat on his ultimatum, but a no vote will be seen as a vote against the status quo in a country that is showing increasing support for antiestablishment parties. Its also a near-guarantee of further problems for Italys troubled banking sector, which is dogged by 350 billion ($371 billion) in bad loans, analysts say.
The most recent polls show the no vote with a lead of 5 to 8 points over yes, with a fifth of voters undecided; the markets put the odds in favor of the former. The FTSE MIB, the benchmark for the Borsa Italiana, Italys main stock exchange, has fallen more than 5 percent in November. The spread between Italian ten-year bonds and the benchmark German Bund has widened to over 1.7 percentage points, near the highest level in two years.
In the event of a no vote, analysts seem to expect Italys flagging banking sector to slide even further. The FTSE Italia Banche index has dropped by more than half since the start of the year. Shares in Banca Monte dei Paschi di Siena, the worlds oldest bank and Europes weakest, according to July stress tests are down 82.7 percent this year. Likewise, shares in UniCredit, Italys largest lender, have fallen 61 percent in 2016. Both banks have plans to raise much-needed capital that would be jeopardized by a change in government and the cloud of political uncertainty that would go with it.
According to Stephen Gallo, head of European foreign exchange strategy at investment bank BMO Capital Markets, the referendum is a lose-lose situation for Renzi. If the referendum fails, the prime minister may be out of a job. But if the referendum wins, the result doesnt change the underlying tone in Italy that is more support for antiestablishment parties, Gallo says.
The proposed consolidation of the Senate following a yes vote, combined with rising support for the populist Five Star Movement which scored big wins in city elections in Rome and Turin in June would make it easier for the group to take over the legislature and advance an agenda that includes a U.K.-style referendum on EU membership.
As if the Italian job wasnt enough, Austria is holding a do-over presidential election on the same day as the referendum. Independent candidate Alexander Van der Bellen beat his far-right rival, Norbert Hofer, in May by some 30,000 votes, but Austrias high court overturned the result after Hofers Freedom Party which has voiced support for a referendum to exit the EU argued that postal ballots had been handled improperly. Polls suggest a tight race going into Sunday.
Worst-case scenario: If Italy has a no vote and Austria swings to the far right, I think euro-dollar could lose 0.75 percent to 1.25 percent in a knee-jerk reaction, Gallo says. (The euro has fallen about 4.5 percent against the dollar this year.) If Italy votes yes, Gallo sees a rally in the euro to 1.08 against the dollar but that would be the time to sell, he adds, as he doesnt expect the exchange rate to reach 1.10. It closed at 1.06 on Tuesday.
Although theres no direct link between the Italian referendum and a vote to exit the EU an Italeave or Quitaly, as observers have dubbed this possibility and the immediate market fallout is likely to be tame compared with Brexit, Italys vote is no less significant.
First and foremost, I think it would be a wake-up call that the sentiment weve seen in the U.S. and U.K. is very much alive in the rest of the euro zone, says Gallo.