Relief at the defeat of far-right candidate Norbert Hofer in the Austrian presidential election swiftly gave way to apprehension late on Sunday evening in Brussels as the results of the Italian referendum became clear. The vote against Matteo Renzi's proposal on constitutional change was divisive - 59.11 per cent against, 40.89 per cent in favour, on a higher-than-expected turnout of almost 70 per cent.
Matteo Renzi, the 41-year-old leader who swept to power two years ago announced he would tender his resignation on Monday. As Italy wakes without a prime minister in place, a number of scenarios now arise.
The president may appoint a successor to Mr Renzi, possibly installing current finance minister Pier Padoan as a caretaker prime minister.
Another possibility is that Mr Renzi could be asked by the president to form another government when he tenders his resignation on Monday, though this is less likely.
Elections that had been expected in 2018 will likely be brought forward to next year. Officials in Brussels are likely to play down the import of the vote, rejecting any analogies with the US presidential election or Brexit.
Italy has had more than 60 prime ministers since 1945, and political stability has long been a feature of the Italian political landscape.
The referendum was not a ballot on EU membership, rather a serious question on a proposed series of changes to the senate and system of local government that would have "streamlined" the political decision-making process. But with figures as diverse as former EU commissioner and finance minister Mario Monti and former prime minister Silvio Berlusconi calling for a No vote, the final result took few people by surprise.
While critics will be quick to criticise Mr Renzi for holding the referendum, much in the way that David Cameron hastened his own political demise by calling a plebiscite that was not needed, that is unfair.
The former mayor of Florence had little choice after failing to secure the two-third parliamentary support needed for his proposed changes. Mr Renzi’s ambition to make Italy more governable was laudable, even if the criticisms that the proposed new system would give the government excessive power rang true for many. The immediate impact of the Italian referendum result will be felt in the financial sphere.
As the euro zone’s third-largest economy, the Italian economy and financial are systemic to the euro zone and European economy. Concerns over the health of the Italian banking system have lingered since the end of the euro zone sovereign debt crisis, with an estimated €360 billion in non-performing loans on the balance sheets of the banks, equivalent to more than 20 per cent of GDP.
Most of the problems are residual. The attempts by the EU institutions and ECB to avert an Italian bailout at the height of the euro zone crisis were successful, but ultimately meant that the banks were never re-capitalized and restructured to a sufficient level as was the case with the Irish, Cypriot or Spanish banking systems.
The lack of growth in the economy, which continues to struggle under one of the highest debt to GDP levels in the euro zone, also exacerbated the non-performing loan problem and worry investors about the long-term future of Italy’s economic model. The fact that retail investors hold about a third of bank bonds, up to approximately €200 billion euro, is also complicating matters.
Mone dei Paschi di Siena
All eyes today will be on the country’s third-largest bank, Mone dei Paschi di Siena, which was already in the midst of a recapitalisation project, trying to convince investors to convert bonds into equity.
The problems in the Italian banking sector also have a specific EU dimension. The Italian government has been locked in debate with the European Commission about securing an exemption from new 'bail-in' rules introduced in the wake of the crisis, effectively prohibiting state bail outs of banks, and instead obliging bondholders, including unsecured depositors.
The issue is particularly sensitive in Italy given the relatively high level of bank debt ownership by regular savers. Tensions between Rome and Brussels don’t end there. Matteo Renzi has been a thorn in the side of his French and German counterparts over the past two years, one of the few senior politicians willing to question Brussels’ policy of austerity.
Italy’s persistent failure to meet annual budget targets set by the European Commission has been a recurring source of tension, with Mr Renzi criticizing the EU rules as too inflexible and prescriptive.
Known for his feisty personality, multiple officials have spoken of his “petulance” at EU summits when he regularly clashed with counterparts.
In February he declared of the EU: “We can’t continue with a technocracy of people who no longer relate to people.”
Those tensions appeared to spill into the open in September when he did not attend a planned joint press conference with the German and French leaders at the Bratislava summit of EU leaders.
With the resignation of Matteo Renzi, Europe has lost one of its strongest champions of a change in direction in European economic policy, something that was signaled last month when the commission called for a fiscal expansion of 0.5 per cent next year across the euro zone.
As it happens, euro zone finance ministers, including Irish Minister for Finance Michael Noonan, are meeting in Brussels this morning for two days of meetings that were already scheduled to discuss member states' draft budgetary plans for next year and the European Commission's new proposal on a positive fiscal stance.
The results of the Italian referendum has just made that conversation a lot more relevant.
In the longer-term, the European political establishment will be looking forward to the next Italian general elections and the implications for the electoral hopes of the eurosceptic party Five-Star Movement. With elections due in France, the Netherlands and Germany next year, Italy has become the latest European country to face an uncertain political future.