For EU governments and financial markets, prime minister Matteo Renzi’s defeat in Italy’s constitutional reforms referendum will intensify unease about the risks of political and financial instability in the euro zone’s third largest country.
In many respects, anxiety about Italy’s political future is overblown. Yet the concerns about the condition of Italy’s banks, public finances and economy are well-founded and demand convincing measures from the nation’s political classes if the shock from Mr Renzi’s defeat is to be contained.
On a momentous Sunday for European politics, the victory of a moderate, liberal candidate over his far-right opponent in Austria's presidential election drew audible sighs of relief in Brussels and EU capitals alarmed about the advances of anti-establishment populism.
But the celebrations were cut short by the referendum result in Italy.
The danger is not that Italy will descend into political chaos or fall into the clutches of the insurgent populists of the Five Star Movement.
Now that Mr Renzi is honouring his campaign promise to resign upon defeat, the most likely outcome is that Sergio Matterella, Italy's president, will appoint a new prime minister to govern the country until the next parliamentary elections, due in early 2018.
The new premier would almost certainly be a safe pair of hands such as Piero Grasso, the anti-mafia magistrate who is president of the Senate, Italy's upper house, or Pier Carlo Padoan, the internationally respected finance minister, or another minister from Mr Renzi's Democratic party.
The premier’s chief task will be to prepare a new electoral law to replace the present system, which awards bonus seats to the winning party and is intended to ensure a government can rule unchallenged for a full five-year term.
The new law will probably change the system so that the bonus seats go to a winning coalition, rather than a single party.
In this way it will actually make it far less likely that the Five-Star Movement, should it win an election, would find itself with a commanding majority in parliament.
Mr Renzi’s defeat may in this sense be a blessing in disguise for those worried about the Five-Star Movement’s idiosyncrasies and its suggestion that Italy should hold a referendum on euro zone membership.
The more immediate and real concerns relate to Italy's banking sector. The referendum result throws into question the ability of Monte dei Paschi di Siena, Italy's third biggest and most fragile bank, to conduct a successful €5 billion capital increase that was planned to take place straight after the vote.
It also puts the spotlight on the weaknesses of other banks struggling under the burden of non-performing loans and low profitability. Financial market nervousness in the light of Mr Renzi’s defeat could add to these pressures.
The risks are particularly acute in Italy because households there own about €170 billion worth of bank bonds.
Should any banks fail, ordinary Italian bondholders would be expected, under new EU rules, to absorb some of the losses. This is a politically toxic prospect.
Yet if the Italian state were to step in to prop up failing banks, it would increase Italy’s public debt, which already amounts to a colossal 133 per cent of gross domestic product.
Underlying these concerns is the awareness in markets that Italy’s economy has barely recorded any economic growth since the nation entered the euro zone in 1999, even though Mr Renzi’s government has presided over a modest recovery since it took office in early 2014 and has passed some well-received labour market and tax reforms.
The outlook for more such reforms now looks bleak, for if Mr Renzi should resign, the next government will hold power for little more than a year, at most.
Its energies will be devoted in large part to revising the electoral law. There is a danger that economic stagnation will resume its grip on Italy.
But the priority in coming days and weeks must be to prevent instability from spreading in Italy’s financial sector. The first test will be the planned rescue of Monte dei Paschi di Siena.
Copyright The Financial Times Ltd 2016