The upcoming Italian constitutional referendum has developed more aspects than the bill and is seen as a way to express discontent with Prime Minister Renzi's government, the 2017 budget and the growth initiative. Moreover, attention on the referendum has risen, with increasing EU scepticism and following the UK's Brexit vote and Donald Trump winning the US election.
Our base case is that Renzi would step down in the case of a 'No' in the referendum. Based on opinion polls, a 'No' seems the most likely outcome of the referendum and the most recent comments from Renzi over the weekend seem to confirm the government would fall if he loses the referendum. In this case, we consider it likely that the President would appoint a technocratic transition government and avoid elections in early 2017, as the voting could then proceed under the 'Italicum' in unchanged form, which would be likely to benefit the anti-establishment Five Star Movement.
In a scenario where the Five Star Movement comes into power, we would not expect an imminent 'Italexit'. Although the Five Star Movement has pledged a referendum on the euro, it has stopped short of advocating an immediate exit from the EU. Furthermore, it is not clear that if such a referendum were held, the majority of Italians would vote in favour of an exit, as support for the EU among the population actually increased following Brexit.
In our view, a 'No' vote would mean prolonged uncertainty for global investors and uncertainty on 'what is next' is likely to cause elevated market volatility and further shake confidence in the European project. However, a 'high' political risk premium is already priced in - hence, the market reaction is very dependent on the political path following the 'No' vote.
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