Will Italy Crisis Send the Euro Lower?

Italy is embroiled in a political crisis and the government is submerged in a case of will they or won’t they. Just weeks following a contentious and historical election, observers are paying close attention to the new right-wing populist coalition government that many feel could blow up or undermine the European Union (EU) by exiting the single-currency trade bloc. These fears are sending jitters throughout equities markets, leaving many investors fearful that Italy will ditch the euro.

Will Italy Cause Panic in Brussels?

Italy has not been immune from the populist uprisings

Across the country, there are concerns about the migrant crisis, worries that the EU leadership is weakening its national sovereignty, and anxieties that the European Central Bank (ECB) is creating lackluster economic conditions. This is part of the reason why Matteo Renzi and his centre-left coalition were trounced in the election, and euroskeptic and right-leaning parties won about two-thirds of the vote.

Prime Minister Giuseppe Conte will lead and represent Italy’s interests moving forward, but analysts concede that Interior Minister Matteo Salvini and Five Star Movement leader Luigi Di Maio wield the real power until May 2023.

The Italian leadership has dismissed the “Quitaly” or “Italexit” risks, and Finance Minister Giovanni Tria has reaffirmed Italy’s commitment to the integrity of the trading bloc and the euro.

That said, it is evident that the new government will challenge Brussels in several areas.

A handful of euroskeptics have been given key lawmaker jobs in the electoral fallout. On Thursday, economist Alberto Bagnai was tapped as head of the Senate finance committee and Claudio Borghi was named the head of the budget committee in the lower House. Bagnai wants to dismantle the European monetary system, while Borghi served as a top economic adviser for the League.

Laura Ferrara, a Member of the European Parliament and a Five-Star figure, noted that “we’ll not get bored” at the European Council. Agriculture Minister Gian Marco Centinaio already confirmed that Italy will challenge the latest trade deal with Canada, CETA, because it does not protect the country’s interests. Italy will also establish alliances with Central European states like Hungary who want more a protective approach at the border.

Like US President Donald Trump, the new coalition government in Rome wants to shake things up.

Financial Markets Take a Hit

Both European and Italian financial markets are sliding towards the end of the trading week following the news of the appointments and the latest fiscal maneuvering.

League and Five Star officials may have found a temporary fix by signing a so-called government contract that issues “instruments such as mini-government notes” that could be utilised to settle accounts with creditors or suppliers. This short-term relief has some warning that these notes could serve as a parallel currency to the euro or as a new form of payment during a hypothetical transitional phase after an abrupt exit of the EU.

Tria told Politico that this is the best way to ensure that the “real problem” is handled.

“The idea points to a real problem — the State’s debts to businesses,” the finance minister said. “I believe that the best way to deal with it is to eliminate it at its root, to ensure that payments are made on time and in cash.”

On these latest events, EURUSD slipped to a 11-month low at 1.1508, stemming from rising Italian bond yields, a rallying US dollar, and the Swiss franc posting impressive gains.

ECB President Mario Draghi has attempted to give the euro a boost by noting the factors that are impacting local wages are diminishing and that he believes eurozone inflation will hit the 2% target aim.

The two-year government bond yield climbed 25 basis points to 0.84%, while 10-year borrowing costs advanced 14 basis points to 2.72%, a one-week high.

FTSE MIB, the benchmark stock index for the Italian national stock exchange, Borsa Italiana, extended its losses by tumbling 1.4%, its biggest drop in two weeks. FTIT 8300, the bank stock index, also slipped 2.1%.

Debt is the biggest fiscal mess plaguing Italy and its financial markets.

The debt-to-GDP ratio is 132%, while its budget deficit represents 1.8% of the GDP, down from 2.3% a year ago. Liabilities could create a fiscal mess in the future as the Bank of Italy’s liabilities reached a record high last month of $548 billion (or 465 billion euros).

Elsewhere in forex markets, the US Dollar Index shed 0.13% to 95.00 on Thursday. The CHF/EUR is about to break the key 0.8700 threshold as the Swiss franc is trading 0.8695.

Conclusion

A key facet of the recent election was the possibility of Italy leaving the EU a la Great Britain. Italian coalition representatives have insisted that Italy will not exit the eurozone, but investors believe that is not the case, considering all of the euroskeptics gaining important appointments.

But perhaps Tria may have said it at best when he spoke to reporters recently:

“The government position is that the euro is not up for discussion. I hope I am not a cause of concern. It is up to other people to decide if I am a worry. In general, I am not.”

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