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December 5, 2016

Euro falls as Italian leader quits after losing reform vote

The euro fell against the dollar and investors braced for a bumpy ride on Monday as Italy appeared headed for a period of political and financial turmoil.

Prime Minister Matteo Renzi announced early Monday that he would resign after his program of constitutional reform was rejected by Italian voters by a clear majority in a referendum.

The prospect of instability in the eurozone's third biggest economy saw the euro drop about 1% against the dollar to around $1.05 in Asia trade, its lowest level in 20 months. U.S. stock futures and major Asian indexes were also moving lower.

Renzi's defeat, and the period of political uncertainty that is now likely to follow, troubles investors for several reasons.

The most immediate concern is a potential banking crisis -- and the risk of contagion around Europe. Some of Italy's banks are drowning in bad debt -- a legacy of years of economic stagnation -- and urgently need to raise new funds.

The world's oldest operating bank, Monte dei Paschi, is the weakest link. It needs 5 billion euros after failing a test of its financial health earlier this year. Its stock has fallen by more than 80% this year.

"A new political storm... could unleash financial market volatility at a time when Italian banks need to raise capital to cover losses from fresh write downs and planned bad debt disposals," wrote Raj Badiani, senior Italian economist at IHS Insight in a note on Saturday.

Italy's economy, which has been stuck in neutral for decades, is also likely to suffer. Renzi's government had embarked on a series of reforms aimed at boosting growth and prosperity.

Many of those are incomplete or still in the pipeline, and progress is now likely to stall. New elections could take place, but they may be many months away. Economists expect growth to weaken sharply next year.

And if they happen, those elections that could prove ultimately to be the biggest headache for investors.

The chief beneficiaries are likely to be populist parties that have capitalized on anger over the economy -- such as the eurosceptic Five-Star Movement.

The party, founded by comedian Beppe Grillo, could campaign on a promise to hold a referendum on Italy's continued membership in the euro.

Investors see Italy as the biggest risk to the future of the eurozone, and they've been selling the country's bonds in recent weeks.

The European Central Bank, which meets Thursday, could announce even more aggressive measures to support the European economy.

-- Charles Riley and Nina dos Santos contributed to this article.

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