Italy’s political and financial woes a threat to European stability

Political instability reached the shores of continental Europe this week as Austrian and Italian voters went to the polls in two very different, but equally important, ballots.

Relief at the defeat of Austria's far-right presidential candidate Norbert Hofer late on Sunday afternoon swiftly gave away to anxiety, as Italian prime minister Matteo Renzi's proposal for constitutional reform was decisively rejected by voters, prompting his resignation.

Across the political landscape in Europe, centre-left governments are losing ground. In France, François Hollande has become the first president in modern times not to seek re-election. In the Netherlands, the government of Mark Rutte is facing a tough battle to retain power in next March's general election. Meanwhile in Britain, the Labour Party is languishing in the opposition benches with no prospect of significant electoral success any time soon.

With the fall of Renzi, another centre-left political figure bites the dust. Renzi may have clashed with his counterparts during his 2½ years as prime minister, but he was a committed European and a powerful voice against the austerity orthodoxy promulgated by Berlin and Brussels.

As the euro zone's third-largest economy, Italy matters.

EU policy

Along with Britain, it has acted as an important counterweight to the Franco-German axis that still tends to dominate the EU. Whoever succeeds Renzi will play a hugely significant role in terms of EU policymaking, from economic policy to Brexit and from the migration crisis to Russia.

But, in the immediate term, the focus is on the domestic political ramifications of the referendum’s defeat.

Officials in Brussels were quick to play down the impact of the referendum, noting that the ballot was not a vote on the European Union, but an internal constitutional matter.

However, due in part to Renzi’s decision to link the referendum result to his own political future, the referendum ballot became politicised, and the result in part a rejection of Renzi’s party and politics.

All eyes are now on Five Star Movement, the Eurosceptic movement founded by comedian Beppe Grillo in 2009.

The party won more than a quarter of the national vote in the 2013 general election. Recent polls have raised alarm bells among the political establishment. Four sets of polls this summer put the party at about 30 per cent, nudging ahead of Renzi's Democratic Party in some cases.

Five Star Movement has emerged as a significant political force, successfully contesting mayoral elections in Rome and Turin this year.

Fake news

Based on an anti-establishment platform, it has built much of its support online, and has faced accusations of disseminating pro-Russian “fake news” content, a charge the party denies.

Whether the party and the right-wing Northern League can translate popular report to electoral victory is another matter. The disappointing performance of Five Star's Virginia Raggi as mayor of Rome, which has been damaged by resignations and controversies over appointments, may hurt the party's chances in a general election.

Much as is the case with Marine Le Pen's National Front in France, Five Star may lack political allies, and Renzi's Democratic Party could join forces with Forza Italia, the party of Silvio Berlusconi, to block Five Star in any government-formation process.

As the permutations of the Italian political landscape play out in the coming weeks, in the short term the main focus will be on the banking sector. With Italian banks struggling under €360 billion worth of non-performing loans, up to eight banks, including the country's third-largest, Monte dei Paschi di Siena, could be at risk. To this extent Thursday's meeting of the European Central Bank is one of the most important in recent times.

German ire

The governing council had been expected to consider tapering its quantitative easing programme, but the political instability engendered by the Italian referendum means it may extend the programme past next March. Such a development would irritate Germany, which has been sceptical about using the bond-buying programme to prop up countries such as Italy.

Simultaneously, behind-the-scenes negotiations will continue this week on a rescue plan for Monte dei Paschi, amid signs a capital-raising exercise under way is at risk of unravelling. Any move by the state to prop up the bank would need to get sign-off from Brussels as it would be in breach of new “bail-in” rules introduced after the crisis. As the main supervisor for the Italian and other euro zone banks, the ECB will also play a central role.

With Europe facing a string of national elections within the next year, the last thing the bloc needs is a resurgent financial crisis. Ensuring that this does not happen will be the primary objective of decision-makers in the coming week.