EUR: Holiday over - Rabobank

Jane Foley, Senior FX Strategist at Rabobank, explains that it has been around eleven weeks since the Italian election and initially the market paid surprisingly little heed with market estimates continuing to favour further EUR appreciation over the medium-term, but over the past few weeks, however, the value of Italian assets has slumped on the back of concerns over Italy’s fiscal position. 

Key Quotes

“Over the weekend, French finance minister issued the warning that if Rome failed to respect the EU’s budget rules the EMU project would be in jeopardy.  Fitch Ratings has stated that the policies of the new Italian government could “significantly increase” the general government deficit.  Italy’s populists, however, have widespread public support.  According the polling firm Demos, 60% of voters had a “favourable” of “very favourable” opinion of a Five Star-League government.  91% of Five Star members are reported to be behind the coalition.”

“In the spring of 2017, Italy’s previous government managed to push through a budget programme that would cut its budget deficit in an effort to placate its EU partners and the European Commission. The government promised to fund this by tackling tax evasion and by announced only limited spending cuts.  The European Commission had threatened to open an excessive deficit procedure against Rome if the government did not take sufficient action to reduce its budget deficit which was in the region of 2.3% of GDP last year.  Italy’s public debt at close to 132% of GDP is the second highest in EMU after Greece’s.”

“Full implementation of the coalition’s core commitments would bring universal basic income, dual flat tax and decreases to the retirement age. While popular with voters, clearly investors are fearful. Yesterday yields on Italian 2 year debt climbed to their highest level since 2015.  The leaders of the two populist parties have accused investors of ‘blackmail’.  As it stands it is not clear how much of the coalitions’ fiscal mandate will be implemented.  This week, talk that the government could attempt to issue short term credit notes ‘mini-BOTs’ to finance extra spending was further undermining confidence in Italy’s fiscal outlook.  Simultaneously, the cracks in EMU were once again re-appearing.”

“In March we changed our house view and argued for a stronger USD vs. the EUR based on our expectation of a broad-based rise in the value of the USD. Last week we revised down our target for EUR/USD to 1.15.  While USD strength is still a factor, EUR weakness is against a large part of the story.”