Mattarella's decision to reject the nomination of Paolo Savona, an 81 year old Eurosceptic economist, as finance minister, led to the collapse of the Five Star/League coalition which was set to become Italy's government.
Justifying the move, Mattarella said that the uncertainty over Italy and the euro had "alarmed" both domestic and foreign investors. As such he moved to try and appease those selling Italian debt and equity, by backing Italy’s continued participation in the eurozone and rejecting a finance minister who has been publicly opposed to euro membership.
But markets did not react well. Italy’s benchmark FTSE MIB fell by over 2% on Tuesday and sovereign bond spreads widened. Whatever short term benefits rejecting Savona had have been outweighed by the constitutional crisis now engulfing Italy.
Mattarella has appointed an interim prime minister, former IMF economist Carlo Cottarelli, but it was clear on Tuesday that he did not enjoy the support of Italy’s parliament. This means that more elections are likely this year — and there's now a strong possibility that Five Star and the Northern League will strengthen their positions in those elections.
This uncertainty is worse for markets than a weak Five Star/ Northern League government would have been.
Italy’s economy is fundamentally sound and the slim majority that the Five Star, League coalition would have enjoyed meant that it would have been difficult for the government to do much lasting damage.
Many investors will continue to be bullish on Italy, despite its politics. GlobalCapital argued last week that equity capital markets investors should still consider Italian IPOs in the event that Five Star and the League formed a coalition.
This fundamentals remain the same, but buyers who were on the fence about Italy now face months more of uncertainty and the resulting volatility.
There is speculation in Italy that Five Star and the League will now form an electoral alliance in a new poll. This would allow them to campaign together on a far more Eurosceptic, and fiscally irresponsible, platform than in March.
Given the language from both parties on Tuesday, they could pitch this campaign as standing up for voters against markets and Eurocrats — groups whose perfidy is illustrated the establishment not allowing them to form a government.
Even if the parties do not campaign together, the League’s growth in popularity since the election means that it would now dominate a centre-right coalition.
By trying to calm markets in the short-term Matarella has brought about further uncertainty and strengthened Italy’s anti-euro populists — and made the long-term fears of Italy's investors more likely to come true.