Eurozone remains in focus despite drastic changes

Over the weekend Italy followed in the footsteps of Greece; the Italian Chamber of Deputies passed the 2012 Budget law, the Senate had already given its approval late last week. Following Prime Minister Silvio Berlusconi’s resignation Italy appointed Mario Monti to head a new technocratic government.

Pressure surrounding Italy persisted, although Mr Berlusconi’s resignation and the approval of the Budget law eased some of it. This did not stop however the yield for the 10-year BTPs (Buoni del Tesoro Polianuali) from reaching the seven per cent key levels throughout last week but also earlier this week.

What is so particular about yields reaching seven per cent? At these levels in the past countries like Greece, Ireland and Portugal ended up asking for a bailout. So why should Italy be different? Well Italy’s outstanding debt is currently estimated around €1.9 trillion; a bailout for Italy could dwarf the capabilities of the eurozone.

While at the end options coined previously this month – for a smaller more united eurozone and a means to allow members to leave the eurozone – might not materialise, they certainly depict the strenuous times for the eurozone. France as well had its share of worries. As the second largest eurozone economy and one of the six eurozone countries holding an AAA rating, France’s poor ranking in a eurozone overall health indicator comes out as a source of concern.

In a eurozone economic health check publication, “The 2011 Euro plus Monitor” issued earlier this week by Berenberg Bank and the Lisbon Council, France ranked 13th out of the 17 eurozone countries just above Italy, Portugal, Cyprus and Greece (in order of ranking); Ireland ranked 10th, Malta ranked 11th and Spain 12th.

On a more positive note the study also says that the huge reforms being currently adopted by the eurozone could eventually make Europe a global economic leader, especially compared to other heavily indebted economies like the US and Japan, who are not currently affecting such drastic changes.

In the former part of this week the EUR/USD was mostly lower, slipping to lows of 1.3512 on Tuesday after Sunday’s open at 1.3783. The single currency was weighed by the strained yields experienced particularly in the Italian debt markets. Other factors also weighed on the euro. Despite the temporary political resolve and the newly set technocratic governments in Greece and Italy Forex investors seemed to realise that change may not be as fast.

The EUR/USD currency pair could be targeting 1.3250 levels as we approach end of year, leaving them single currency susceptible to the current ongoing eurozone debt issues and related headlines. From the economic docket, eurozone industrial output contracted for the month of September slipping lower by two per cent compared to the previous month’s 1.2 per cent growth. Preliminary Q3 GDP figures for the eurozone remained positive but also pointed towards some signs of easing.

UK inflation data for October eased to 0.1 per cent from the previous 0.6 per cent and the expected 0.2 per cent; while the yearly figure slipped to five per cent from the previous 5.2 per cent. The easing inflation continues to fuel expectations for loose monetary policy from the BoE. The eurozone episodes also left its mark on sterling given the country’s links to the troubled group but also as the liquidity appeal favoured the US dollar.

Against the dollar the GBP followed the euro’s path and while the GBP/USD opened the week at 1.60675 it slipped to lows of 1.5829 by Tuesday in line with our expectations. An extension lower could still be in the cards for the mentioned currency pair, possibly targeting 1.5660 levels as early as this week.

RBA minutes for their October 31 meeting published early Tuesday showed that the decision to cut the policy rate to 4.5 per cent was more of a last minute decision, as it appeared that the board had seriously considered it should stay on hold.

While this initially gave the Aussie support because the minutes tended to imply that the Reserve Bank of Australia will most probably not rush into further rate cuts, support soon fizzled out as risk appetite continued to lose traction.

Upcoming FX key events:
Today: UK Retail Sales, US Philadelphia Fed Business Index.
Tomorrow: German PPI, Canadian CPI and US Leading Indicators.

FX technical key points:
EUR/USD is bearish, target 1.3250, key reversal point 1.41.
EUR/GBP is neutral.
USD/JPY is neutral.
GBP/USD is bearish, target 1.5125, key reversal point 1.6170.
USD/CHF is neutral.
AUD/USD is bearish, target 0.9600, key reversal point 1.0745.
NZD/USD is bearish, target 0.7468, key reversal point 0.8239.

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Mr Muscat is a senior trader at RTFX Ltd.