Increased political risks in Italy may result in the breakout of the support at 1.143-1.145

Hope for the best, prepare for the worst. The Euro has been ignoring the Italy’s political crisis for some time, hoping for a compromise between the conflicting parties. However, the first disagreement between Rome and Brussels resulted in a wider yield-gap between Italian bonds and their German peers, which hit its highest levels since 2013, driving the single European currency to a dangerous edge. The breakout of the support at $1.143-1.145 may result in a faster decline, especially since the U.S. dollar has the advantages of the economy growth-gap and the divergence in monetary policies.

According to the European Union, Italian budget plan is a significant departure from accepted rules, the state expenses are too high, and the structural deficit is going to increase, rather than cud down as Rome promises, which is to result in the bigger state debt. Italian Economy Minister Giovanni Tria responded that the EU and Italy had different ideas about the state policy and expressed the hope that after negotiating the parties would reach an agreement. The conflict is getting worse, and, if investors kept calm for some time due to the idea that Brussels would rein the dissidents, now the markets have doubts. Italy is not Cyprus, Greece, Ireland or Portugal; and Italian banks have so close ties with European ones, that the crisis is going to of far greater scale.

Dynamics of Italian/German bond yield spread

Source: Bloomberg

In addition to unfavorable political environment, the euro is put a pressure on by the monetary policies, held by the Fed and the ECB. According to Bloomberg experts’ consensus forecast, the Governing Council will not abandon the negative deposit rate until September 2020. The interest rate on the main refinancing operation will be raised in late 2019 for the first time. By that time, the fed funds rate will have been up at 3.25%, and the gap will be as wide as 3%, compared to the present 2.25%; which a serious bearish factor for. Experts suggest Italy’s political crisis to be the biggest danger for the Euro-area, while the risks of trade wars are assessed as balanced.

Forecasts for the ECB interest rates

Source: Bloomberg.

Estimate of Euro-area risks

Source: Bloomberg

The situation in Italy has overshadowed the report on the worst results of China’s GDP growth for almost 10 years. The indicator has added 6.5%, having met Bloomberg expectations; China’s officials have tried to calm investors, stating that the recent turmoil in the financial market doesn’t show the country’s strong fundamental indicators and its steady financial system. According to Capital Economics, the mass fiscal stimulus will lay a foundation for GDP rate increase in about mid-2019.

EURUSD bulls will try to hold the positions close 1,143-1,145. If they fail and lose control, bears will be encouraged to go ahead.

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Price chart of EURUSD in real time mode

Euro Looks For More Trouble

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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