FYI | Dec 05 2016
By Kathleen Brooks, Research Director, City Index
Italy’s Prime minister has suffered a crushing defeat in today’s constitutional referendum. The No camp appears to have won by an impressive 60% to 40% on a very high turnout. Renzi will resign tomorrow, it will then be up to the President to try and form a government in the next 70 days, otherwise the Italians will be heading back to the polls to vote for a new Prime Minister at some point in Q1.
Could there be a Trump moment for European markets?
The euro initially plunged to a low of 1.0506 on the back of the result of this vote, to its lowest level since 2015. However, there have been some early signs of stabilisation in the FX market since Renzi announced that he is resigning. Could there be a Trump moment for markets? And after an initial sell off, selling pressure could start to ease.
Will the ECB cut rates this week?
We will have to see how the markets will react to this decision on Monday [night], but could the prospect of further rate cuts from the ECB, who meet this week, actually boost risky assets in the next few days? While the markets are likely to remain nervous as we start a new week, they haven’t fallen of a cliff, so far. Either markets are becoming immune to political risk, or they are taking the view that the Italian issue will be a slow-burner, even if the President can’t form a government, he still has 70 days to try and that seems quite far away at this stage.
It’s all about the banks, the banks, the banks…
However, Italy’s banks don’t have time to waste to try and boost their capital buffers. A win for the Yes camp in this referendum could have seen investors help to recapitalise the banks, however, it is unknown whether investors will do so now that the No camp have prevailed. Without a sitting government, will there be official help for Italy’s beleaguered banking sector?
Another cause for concern is Europe’s wider banking sector, including Deutsche Bank. Negative interest rates from the ECB have hurt banks’ profitability in Europe. If the ECB does cut rates further into negative territory this week then we could see broad-based declines for Europe’s banking sector in the coming weeks.
So far, this is not Italy’s Brexit moment
There is still a risk that this decision could trigger nervousness in financial markets, but for now at least, this does not appear to be the euro’s Brexit moment. We believe that the market reaction to this result could be a slow-burner, but that the outcome of this referendum is another reason to sell the euro for the long term, and avoid European stocks. Europe’s banking sector is the weakest link, however the European authorities would be mad to let Italy’s banking sector go to the wall just because there is no government in place in Rome. The markets aren’t pricing in the possibility of an Italian banking collapse so far on Sunday night, which could limit the downside for the euro on Monday.
Overall, the subdued reaction from the early market open suggests that the market is not pricing in the prospect of a Beppe Grillo led Five-Star Movement government, or an Italian EU referendum, at least not yet, anyway.
Ahead, we also have the result of the UK government’s appeal to the Supreme Court on the Article 50 decision. We will also be watching closely for any further fallout from the No vote in the Italian referendum; and any developments regarding the banking sector and the forming of a temporary government.
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