Italy's Renzi to resign after referendum rout

ROME (Reuters) - Italian Prime Minister Matteo Renzi is set to resign on Monday after suffering a crushing defeat on Sunday in a referendum on constitutional reform, tipping the euro zone's third-largest economy into political turmoil.

His decision to quit after just two and a half years in office deals a blow to the European Union, already reeling from multiple crises and struggling to overcome anti-establishment forces that have battered the Western world this year.

The euro briefly tumbled overnight to 20-month lows against the dollar, as markets worried that instability could reignite an EU debt crisis and deal a hammer blow to Italy's fragile banking sector, especially the troubled Banca Monte dei Paschi di Siena. However, by early in the European morning it had largely rebounded. [FRX/]

Monte Paschi shares were suspended, initially falling 7 percent before bouncing back to a 1-percent decline. Yields on Italy's benchmark 10-year bond soared to more than 2 percent, but then also retreated back below that mark. [GVD/EUR]

Economy Minister Pier Carlo Padoan, seen as a possible candidate to replace Renzi, will miss scheduled meetings with European finance ministers in Brussels on Monday and Tuesday, a Treasury source said.

Renzi's resignation could open the door to early elections next year and to the possibility of an anti-euro party, the opposition 5-Star Movement, gaining power in the heart of the single currency. 5-Star campaigned hard for a 'No' vote.

"I take full responsibility for the defeat," Renzi said in a televised address to the nation, adding that he would hand in his formal resignation to President Sergio Mattarella on Monday.

"I will greet my successor with a smile and a hug, whoever it might be," he said, struggling to contain his emotions when he thanked his wife and children for their support.

"We are not robots," he said at one point.

"No" won an overwhelming 59.1 percent of the vote, according to the final count.

About 33 million Italians, or more than two-thirds of eligible voters, cast ballots following months of bitter campaigning that pitted Renzi against all major opposition parties, including the anti-establishment 5-Star.

Mattarella will consult with party leaders before naming a new prime minister -- the fourth successive head of government to be appointed without an electoral mandate, a fact that underscores the fragility of Italy's political system.

The vote ended months of campaigning for a reform that Renzi had said would bring political stability to Italy -- but that opponents said jeopardized democratic checks and balances.

The new prime minister, who will need the backing of Renzi's Democratic Party (PD) to take office, will have to draw up a new electoral law, with 5-Star urging a swift deal to open the way for elections in early 2017, a year ahead of schedule.

"From tomorrow, we will start work on putting together 5-Star's future program and the team of people that will make up a future government," said Luigi Di Maio, tipped to be the group's prime ministerial candidate.

Opinion polls put 5-Star, which wants to hold a referendum on membership of the euro, neck-and-neck with the PD.

DEMOLITION MAN

Renzi, 41, took office in 2014 promising to shake up hidebound Italy and presenting himself as an anti-establishment "demolition man" determined to crash through a smothering bureaucracy and reshape creaking institutions.

Sunday's referendum, designed to speed up the legislative process by reducing the powers of the upper house Senate and regional authorities, was to have been his crowning achievement.

However, his reforms so far have made little impact, and the 5-Star Movement has claimed the anti-establishment banner, tapping into a populist mood that has seen Britons vote to leave the European Union and Americans elect Donald Trump president.

In one moment of relief for mainstream Europe, Austrian voters on Sunday roundly rejected Norbert Hofer, vying to become the first freely elected far-right head of state in Europe since World War Two, choosing a Greens leader as president instead.

But elsewhere, the established order is in retreat. French President Francois Hollande announced last week that he would not seek re-election next year, and even German Chancellor Angela Merkel looks vulnerable as she seeks a fourth term in 2017.

The biggest immediate loser from Italy's 'No' vote could be Monte dei Paschi di Siena, Italy's third-largest bank, which is weighed down by bad loans and looking to raise 5 billion euros ($5.3 billion) this month to stave off collapse.

The consortium of bankers supporting Monte Paschi's cash call will meet at 1100 GMT, a source familiar with the situation told Reuters.

Investors are likely to shun the operation if political chaos prevails, meaning a state intervention will be needed to save the bank. Several other lenders also need a cash injection to stay afloat, raising fears of a domino effect.

Economy Minister Padoan sought to calm nervous markets on Friday, saying there was "no risk of a financial earthquake" if 'No' won, though there might be "48 hours of turbulence".

(Additional reporting by Steve Scherer and Isla Binnie; Editing by Kevin Liffey)