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Analysis
European fragmentation accelerates

European fragmentation accelerates

Renzi victim of misplaced self-confidence

by David Marsh in London

Mon 5 Dec 2016

Suddenly, in Europe, everything and anything seems possible. Italy’s No to Prime Minister Matteo Renzi’s constitutional reform proposals – although widely trailed in the last few weeks – may trigger a period of destabilising change that could eventually escalate into that much-pondered outcome, the departure of a large member country from the euro.

Renzi said last night he would resign in the wake of what appears likely to have been a heavier than expected referendum vote against his proposals. In a statement after midnight in Rome, he took responsibility for the outcome, apparently accepting what many critics had claimed was a major error in transforming a plebiscite on streamlining government to a popular vote on his own future.

Once the standard-bearer of an ambitious campaign to reinvent and redynamise Italy, Renzi now stands revealed as the victim of overwhelmingly misplaced self-confidence.

The Italian setback results from a similar anti-establishment swing to those seen in the UK in June with the rejection of Britain's membership of the European Union, and in the US last month with the election of Donald Trump.

However, in a consolation prize for mainstream parties, Alexander Van der Bellen, a Green politician who ran as an independent, won 53% of a vote in Austria yesterday to become the country’s next president. He fended off his far-right opponent, Norbert Hofer of the Freedom party, who won 47%, according to projections in Vienna.

The danger for Italy now is that a string of unpredictable outcomes – ranging from a difficult-to-control euro decline to a run on troubled Italian banks and a further loss of credibility of the European Central Bank – could ensue. With the main opposition parties that backed the No vote all declaring their wish to leave the euro, and anti-establishment groupings gaining ground in other important member countries including France, European fragmentation is plainly accelerating.

The Italian No could have a similar impact on Europe to that unleashed by President Charles de Gaulle’s resignation in April 1969 when, in a referendum, voters turned down his plans for constitutional changes. De Gaulle’s departure helped spark a chain of events that led to a devaluation of the French franc against the D-mark, the entry of the UK into the European Economic Community and the breakdown of the Bretton Woods system of fixed exchange rates. If history repeats itself, the denouement could severely damage the euro, perhaps in line with the well-known credo of Rüdiger Dornbusch, the late German economist: ‘In economics things take longer to happen than you think they will, and then they happen faster than you thought they could.’

The Italian poll was designed to determine a new power split between the Chamber of Deputies and the Senate which many critics, including moderate pro-Europeans such as former Prime Minister Mario Monti, claimed was badly crafted and would unfairly entrench executive power.

Yet the main reason for the rejection appears to have been popular distaste for the policies of a pro-European ‘elite’ who have become progressively out of line with the views of ordinary voters suffering from lacklustre growth, sluggish incomes and high unemployment.

The vote will overshadow a decision by the ECB on Thursday on how to continue its €80bn a month bond purchase programme beyond the present cut-off date in March 2017, amid expectations of higher inflation and interest rates in the US driven by Trump’s fiscal plans.

ECB hawks may have to abandon any idea of a cutback in bond purchases, faced with the all-encompassing wish to help Italian banks – even though this could arguably stand in opposition to the core tenets of the ECB’s mandate.

Renzi has continuously maintained that, if he lost the plebiscite, he would not stay on as a lame duck leader.

Italy’s short-term future is now in the hands of President Sergio Mattarella, who has to decide whether to reappoint Renzi – unlikely in view of what appears to have been a comprehensive defeat – or ordain a so-called ‘institutional government’ to carry on until the next general election due in early 2018. One well-known technocrat who could take the reins as prime minister is Pier Carlo Padoan, finance minister, who has been widely cited as a possible stabilising force.

However, faced with discontent from the anti-establishment Five Star Movement, led by Beppe Grillo, as well as other anti-immigrant, anti-euro parties such as the Northern League and Brothers of Italy, a technocrat-led government without an electoral mandate could turn out to be only a temporary bulwark against the growing tide of populism rippling across Italy and Europe.

David Marsh is Managing Director of OMFIF.

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