EUR/USD: Italy's GDP could spark the next significant move

Italy is the euro zone's third-largest economy, and its economic figures rarely move the Euro. But the preliminary publication for Q3 2018, due on October 30th, will be different. Very different. 

This time is different. 

Rome vs. Brussels

Italy is clashing with the European Commission over its budget for 2019. The southern-European nation has drafted a budget that foresees a deficit to GDP ratio of 2.4%, breaching the EC's request for a limit of 2%. Itay's debt-to-GDP ratio stands at around 130%, second in the euro-zone only to Greece. 

The Lega party insists on tax cuts while the 5-Start Movement demands a Citizens' Income program. They say that without these measures, Italy will never emerge from its slow growth.

The government did not heed to warnings from Brussels and is submitting the budget to parliament on the same day.

Is growth slow? Yes. The economy did not boom in the early 2000s when its neighbors were on the rise, and it never saw an acceleration in growth in the post-crisis years. Back in Q2, the economy grew by only 0.2% while the euro-zone enjoyed a growth rate of 0.4%. Year over year, the nation's economy expanded by 1.2% and the euro-zone by 2.1%.

Similar figures are expected this time: 0.2% QoQ and only 1% YoY in Q3.

Scenarios 1 and 2: Clash continues, and EUR/USD falls

If the actual data meets expectations, each side will keep digging in its heels. Italy will say that previous policies were failed and that debt-fueled growth is necessary to kick-start the economy. The EC will likely insist that the ongoing high debt-to-GDP ratio will mean that a smaller deficit is essential.

If the economy grew at an even slower pace, the clash would become even harsher. Both sides will feel they are vindicated in their positions. 

In both scenarios, the EUR/USD will likely suffer as the crisis continues.

Scenario 3: Climbing down the tree

If Italian GDP beats expectations for any reason, it could allow both sides to climb down the tree. A higher GDP means a lower debt-to-GDP ratio, allowing the EC to allow for a more significant deficit in the budget. It may also enable the Italian government to present a smaller deficit to GDP ratio in 2019 using the exact same plan.

In the optimistic scenario that Italy enjoys more than meager growth, both sides could smile and begin negotiations. It does not mean an immediate solution, but it will certainly allow for some breathing room. 

The EUR/USD could rise on this relief, even if it is temporary. 

Conclusion

Italy's GDP publication is essential this time due to the focus over the 2019 budget. If the economy grows by 0.2% QoQ or less, it would make aggravate the crisis and weigh on the Euro. A beat on expectations could allow both sides to climb down and the Euro to climb up.