Italians have firmly rejected proposed constitutional reforms, forcing prime minister Matteo Renzi to resign and throwing open the prospect of fresh elections in 2017. So where now for Italy and the markets?

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What the result means

 

The chief casualty is prime minister Matteo Renzi, who resigned in the wake of the result. While the government could stagger on, but the scale of the defeat could make this harder. We have to consider an election next year. Finance minister Carlo Padoan could take over in the interim to guide Italy in the meantime.

With the anti-EU, Five Star Movement riding high in the polls on the populist wave, there is a chance the party could form the next government.

EU officials are playing down the significance of the vote, saying it’s just an internal poll on constitutional reform. However it was Renzi who made it personal and it’s hard to look at this resounding rejection of his regime as a snub to the status quo politics.

Market reaction

 
The response in the markets has been volatile, with stocks swinging from gains to losses in pretty short order.

The FTSE MIB opened over 2% lower, well within its recent trading range, before rallying to trade up 1% on the day and then falling back to trade flat.

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Italian banks slid across the board on the open but even here we saw some diverse early trading. Banks including UniCredit and Monte dei Paschi di Siena swung between gains and losses before edging lower.

A ‘No’ vote had already been priced in although the scale of the defeat for Matteo Renzi has surprised and leads to the prospect of fresh elections next year.

After dipping to a 20-month low against the US dollar, the euro is holding firm in the face of the political uncertainty but this may not last. EURUSD rallied to 1.0646, where it was when the first exit polls were announced on Sunday night.

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Italian bond yields have spiked but only to levels seen in November ahead of the referendum. The prospect of the ECB accelerating Italian bond purchases is helping. However we also need to watch for DBRS, the only ratings agency that lets Italian banks enjoy cheap funding. If it cuts Italy down it would force Italian banks to hold more collateral to borrow from the ECB.

Banks

 

The chief risk at present is the banks and specifically the €5bn cash call by Monte dei Paschi di Siena which was due to start this week. This now looks in grave danger and we have to consider a possible state rescue to shore it up and prevent contagion spreading. We can expect plenty of soothing words from Eurogroup ministers who meet today, as well as ECB chief Mario Draghi.

UniCredit, Italy's only global systemically important lender, is set to raise €13bn next year. While this banks overall is in better shape, there are several other lenders at risk.

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