EUR talking points:
- So far, Euro traders have paid little attention to Italian politics. However, looking ahead, a modest risk premium will likely have to be priced in.
- Italian government bonds and Italian stocks will also likely suffer.
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Italian political risk
A leaked draft of the program being discussed by the anti-establishment Five Star Movement (M5S) and the far-right League, which are trying to form a new Italian government after indecisive elections on March 4, contains several proposals that could affect the Euro, Italian government bonds (BTPs) and Italian stocks.
In particular, the two parties are proposing asking the European Central Bank to forgive €250 billion of Italian debt, seeking a reduction in Italy’s contribution to the EU budget and looking to renegotiate the EU’s financial rules for member states. Crucially, though, the draft document contains no call to exit the EU or the Euro-Zone.
In the currency markets, there has been little reaction in the Euro, which has been falling on USD strength. However, the Euro has also eased gently against GBP, even though the Pound is suffering from both Brexit concerns and reduced expectations of a UK interest rate rise. This suggests a small risk premium being built into the Euro and that premium will likely increase modestly.
EURGBP Price Chart, Daily Timeframe (September 4, 2017 – May 16, 2018)
Meanwhile, the yield on the benchmark Italian government bond has risen above 2% to 2.024% and the spread – or yield premium – over the equivalent German Bund has climbed above 140 basis points. That spread will likely rise further as the prospect of an M5S/League government comes closer.
Similarly, the FTSE MIB index of Italian stocks, which hit 24,544 on May 7, has since eased to 23,904 and could well drop further.
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--- Written by Martin Essex, Analyst and Editor