For over two decades, the pace of Italy’s economic growth has lagged that of its major continental peers. Burdened by overly indebted banks, heavy regulation and weak productivity, Europe’s fourth largest economy has made its fair share of financial headlines.
On paper, the referendum this weekend only concerns the domestic matter of Italian constitutional reform. In practice, voters, politicians and financial analysts are likely to view it in the context of a wider global trend. Like the UK’s EU referendum and US election after it, Sunday’s vote is not just about domestic politics; it could be symbolic of the rise of populist, anti-globalisation sentiment sweeping the Western world.
Italy isn’t the only European nation heading to the polls this weekend. The Austrian presidential election is taking place too, while the German, Dutch and French elections are scheduled for 2017. These European nations are also witnessing the rise of “alternative” right-wing parties, with each promising a departure from the recent political and economic status quo.
Italy’s Prime Minister Matteo Renzi has confirmed he will stand down if the electorate votes against the reforms. As such, the vote carries extra significance, particularly for Italy’s own “alternative” party: the Five-Star Movement.
It remains unclear whether the party, led by former comedian Beppe Grillo, is an outlier versus other anti-establishment parties in Europe. However, its focus on harnessing anti-euro sentiment and reshaping the political system is familiar. Could the success of the UK’s Brexit vote and Donald Trump’s victory be a blueprint for other developed nations?
If Italy votes No, Renzi stands by his word to resign and a general election is ultimately called, it is not immediately clear how the Five-Star Movement could seize power. Being the largest party in a coalition government would be the traditional route, but the party has categorically ruled this out. The Italian political system also has numerous checks and balances, so any major changes could face significant opposition.
Of more immediate concern for financial markets is the future for Italian banks. A Yes vote would reinforce Renzi’s position, making bank recapitalisations easier. Italian equities are under-owned, reaching 30-year relative valuation lows, and could rally as political uncertainty is priced out.
A victory for No, meanwhile, could see Renzi go back on his word to stay in the office and still recapitalise Italy’s ailing banks. Alongside an extension of easing from the European Central Bank, this might provide a constructive backdrop for European equities.
A big winning margin for No, however, is more likely to see Renzi resign, causing equity market volatility and casting doubt on future bank recapitalisations. Against this hugely uncertain political and economic backdrop, we as investors remain cautious on European equities – particularly with regard to continental nations characterised by growing anti-establishment sentiment and weak banking systems.
The potential for political change across Europe has implications for the UK. Theresa May has recently reiterated that Article 50 will be triggered before the end of March, which will start the two-year clock for the UK to leave the European Union. As the swathe of electoral results across Europe come in over the next year, it will become increasingly clear to what extent political change will be driven by populism. Sunday’s vote in Italy could provide clues about what could be in store for other developed nations.
In the UK, political focus is likely to remain on negotiating future trade terms with Europe in the wake of our own referendum vote. Yet if more European political change is in the pipeline, understanding the Europe we are negotiating with will be no easy task.