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Italy’s banking and constitutional crises threatens Europe

14 th July 2016
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Britain’s decision to leave the EU has divided the country, shocked the establishment and led to the resignation of the Prime Minister. The speed of events is extraordinary with Theresa May already announcing the first few members of her cabinet. Parliament rises for its summer recess on the 21st of July and MPs will not return until the 5th of September, unless called back in emergency. Nonetheless, there will be much going on behind the scenes.

British officials have already begun unofficial talks with countries such as China, India, Australia and New Zealand to assess the potential for trade agreements before Article 50 of the Lisbon Treaty is invoked and Britain starts the formal two year countdown to leaving the EU. UK markets were supported on Monday, when it became clear that Britain had a new Prime Minister without the uncertainty of a leadership race. Nonetheless, Bank of England Governor Mark Carney appears to have taken a leaf out of ECB President Mario Draghi’s book, and has adopted a ‘whatever it takes’ approach to maintain stability in the UK economy. Indeed, at the time of writing, the market assesses the probability of a base rate cut today to 0.25% at 83%.

It is not just the UK, however, that faces a big question mark over the EU. The victory of Virginia Raggi, of the Movimento Cinque Stelle or M5S (the Five Star Movement), has seen her become the first woman in charge of Rome for over 2,500 years – and this turn of events should not be underestimated. Her election is a sign of the Italian voters’ loss of patience with established political figures and perhaps even the Italian political system itself.

While Raggi’s victory in Rome was expected, Chiara Appendino’s win in traditionally leftist Turin was not. M5S’s anti-EU credentials are well documented. Meanwhile, Prime Minister Mario Renzi’s constitutional reforms will be voted on by the Italian people in a referendum to be held no later than October. These changes to the constitution are aimed at making the government more efficient and stable, with laws able to be passed more quickly. Presumably it has always been Renzi’s intention that, following a post-referendum election, he would be the first beneficiary of these changes. His nightmare is that Beppe Grillo, the M5S leader, will instead come to power with much more durability than the average post-war Italian leader. It may seem unlikely that the Italian electorate would compromise to such an extent its relationship with Europe in order to punish the establishment; however, given M5S’s strong performance in opinion polls, this could be the unintended consequence.

If M5S can indeed convert its recent mayoral triumphs into success at a national level, Europe faces the prospect of the citizens of its third largest economy and, more importantly for financial markets, the world’s third biggest bond market – holding a referendum on their continued membership of the EU – and, by definition, of the euro.

It is most unfortunate for Renzi that there is currently a desperate need to provide state aid to Italian banks. EC rules forbid such state aid without imposing haircuts on creditors. Renzi must assist the banks but he cannot afford to punish small savers who would be unlikely to forget such ill-treatment and would, if any of their money were confiscated, inflict vengeance on their representatives in government.

Some have commented that Britain’s vote to leave will sound the death knell for the EU. That is highly unlikely: the UK has never been politically, geographically, economically or culturally at the heart of Europe. Furthermore, Britain was ejected by the markets from the European Exchange Rate Mechanism – the forerunner of the euro – in 1992 and never joined the euro itself. Italy is an entirely different matter. It is no exaggeration to say that the EU and the euro face an existential threat, but it does not come from Britain.

It is not all bad news, however. We learnt yesterday that Italy is apparently closer to an agreement with the EC to avert the banking crisis and that Spain and Portugal will probably not be fined for exceeding the 3% fiscal deficit limit. Perhaps even EC President Jean-Claude Juncker is beginning to understand the error of his intransigent ways and the EU will be better able to navigate the treacherous waters ahead.

James Stretton

All views expressed here are the author’s own and are based on information and data available at the time of writing.




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