Euro: Understanding the Impact of Italy’s Budget Review Vote

Talking Points

• Italian Budget Vote in Focus, Markets Looking for Signs of Government Cohesion
• Euro, Risky Assets to Rise if Vote Outcome Appears to Help Passage of Austerity
• UK Industrial Production to Slow, Reinforcing Weak Housing and Sales Reports

All eyes are on Italy as the government submits its 2010 budget for review vote in Parliament at 14:30 GMT. While the poll itself is largely procedural, markets are looking at the vote tally to see if Prime Minister Silvio Berlusconi retains a governing majority. If he fails to get 316 votes needed for the budget review to pass, a confidence motion will likely follow that threatens to unravel the current administration. Fears that he may fail to do so spread after three policymakers defected to the opposition last week and six more openly called on the Prime Minister to quit.

For their part, the markets are most worried about a political vacuum that holds back implementation austerity measures meant to trim Europe’s second-largest debt burden. With that in mind, the immediate concern is not whether Berlusconi goes or stays, but rather if whatever government is holding the reins in Rome is able to be effective at advancing its agenda. Italy is preparing to roll over €14.9 billion in maturing debt this month, with €6.1 billion set to mature as soon as next week. If the vote’s outcome fails to assure investors enough to bring down soaring borrowing costs and threatens Rome’s ability to meet its obligations, markets may find themselves facing the worst-case scenario for the evolution of the EU debt crisis: an imminent threat of default in a country too big to be bailed out.

On balance, this presents traders with four scenarios. If the administration secures a relatively comfortable victory or if a failure to do so produces a swift transition of power to an effective care-taker government able to push through austerity, the Euro as well as the spectrum of risky assets are likely to rise while the safe-haven US Dollar falters. Alternatively, a narrow victory for the Prime Minister that falls short of mollifying investors’ concerns about his ability to govern or the fall of the sitting government that brings early elections – which would prolong the current state of limbo – is likely to have the opposite effect.

Elsewhere on the docket, UK Industrial Production figures are set to show output growth slowed in the September from the previous month, adding 0.1 percent. Production is set to decline 0.8 percent from a year ago, marking the third consecutive decline and the seventh month since the last increase (annualized growth was flat in June). The result comes on the heels of disappointing Retail Sales and House Price figures from BRC and RICS respectively published overnight, setting a negative tone ahead of the Bank of England interest rate decision on tap later in the week. With that in mind, it seems unlikely that the central bank will meaningfully alter the policy mix having just topped-up its asset purchase program last month.

Asia Session: What Happened

Euro Session: What to Expect

Critical Levels

--- Written by Ilya Spivak, Currency Strategist for Dailyfx.com

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