Italy's Government Falls Posing More Danger For EU

In another blow that could lead to the collapse of the European Union, the government of Matteo Renzi in Italy has fallen after the large defeat of a constitutional reform referendum upon which Renzi had staked his leadership. Renzi’s resignation will likely lead to national elections early next year which will probably become a referendum on Italy’s place in the European Union. Renzi’s pro-EU Democratic Party will be opposed by the 5 Star Movement which advocates withdrawing from the currency union. Right now polls show the two running neck and neck.

In the meantime, economists and the world’s central bankers are keeping a close eye on Italian banks that are still enormously over-leveraged and in danger of collapse. Italy’s third largest bank, Monte dei Paschi di Siena, needs to raise over $5 billion on the coming days to avoid collapse. The chaos and instability from Renzi’s loss has already raised borrowing costs in Italy by over an eighth of a basis point and makes it more unlikely that the bank will be unable to raise the money it needs from outside investors. That could likely mean another government bailout which will only fuel the anger among those still suffering from austerity and the economic straightjacket imposed by being a member of the Euro.

Another potential side-effect could be the Fed’s decision to raise interest rates, which is priced in and expected in just another week or so. With Italian banks teetering, the Fed may think twice before moving interest rates up only to face possible financial contagion from a collapse of an Italian bank. If they do delay, this will be the second time this year that the Fed has been forced to back away from an almost sure interest rate hike because of events in Europe, the first being Brexit back in May.