Italy on the verge of political implosion

• Berlusconi antics threaten Letta government, confidence vote on Wednesday

• US politicians no closer to avoiding shutdown

• China data disappoints, Aussie inflation remains low

It really wouldn’t be autumn without a political crisis in the Eurozone; as soon as we hear the sound of conkers falling to the ground, look to Europe and an almighty political squabble.

This year’s will be an Italian crisis following moves over the weekend that have significantly destabilised the government of PM Letta. Silvio Berlusconi requested that 5 members of his coalition resign from the coalition, ostensibly over a vote around a percentage point increase in VAT; the fact that the hearing to expel Berlusconi from Senate is due this Friday is just a happy coincidence.

A meeting between the PM and President Napolitano last night ended with a call for a vote of confidence in the Letta government on Wednesday. Failure to pass that would likely see a new election needed in Italy. Berlusconi and Beppe Grillo’s anti-austerity parties did the best in February’s elections and following further contractions in economic output since, you would have to think that those opposed to spending cuts will remain strong at the ballot box. No government will come from these two though; Berlusconi will not ally with Grillo and Grillo will not ally with anyone.

The danger to the euro from this is significant. Italy is the world’s 3rd largest bond market – after the US and Japan – and therefore poses quite the issue. Is the Italian bond market too big to fail and at the same time too big to save? This is what the market will be looking for with Draghi’s “whatever it takes” mantra still fresh in their collective memory. The euro is lower across the board this morning as a result.

In a competition between the US and Italy over which set of politicians could foul up recent legislation the most, I would have to say my vote would still go to the US Congress. There seems to have been little movement over the weekend to obtain a decision to renew government funding and if a deal is not reached by midnight Washington, then portions of the US government will close for the first time since 1996. Some expect that the US economy will lose around $8bn a week as a result of these closures.

Growth numbers from China last week suggested that a recovery may be gaining a foot hold. Figures overnight have cast doubt on that, however. HSBC’s survey of the manufacturing sector came in at 50.2 – just above the 50.0 level that delineates expansion and contraction – missing expectations. Given tomorrow is the first day of the new month, we will be seeing a lot more data from the world’s manufacturing sector in the next 36hrs.

While we are not looking for a cut from the Reserve Bank of Australia meeting this week – our thoughts are that we will see one in November – inflation is unlikely to prove a barrier to rate movement anytime soon. Rates are currently at an all-time low of 2.5% and inflation overnight was very much towards the low side of the 2-3% band that the central bank is looking for. The AUD is close on 5 cents stronger since the most recent RBA meeting however, and given the fears of over-valuation, may trigger some dovish comments from central bank members. They meet overnight.

Have a great day.