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Foreign Exchange

Berlusconi departure is no panacea for the euro

The job prospects of Italian prime minister Silvio Berlusconi are dominating price action in the euro, but his departure is unlikely to trigger a sustained rally in the single currency.

The FX market has made it clear what it thinks of Berlusconi’s stewardship of the Italian economy and his ability to make the reforms necessary to put the country’s finances in order. When speculation heightened that he was set to stand down on Monday, EURUSD rose by one US cent in a matter of minutes, while Italian stock and bond markets advanced..

Subsequent denials took the steam out of the single currency’s rally and the market’s focus has turned to whether Berlusconi can hold on to power as the Italian parliament debates his government’s budget plans on Tuesday.

Lutz Karpowitz, FX strategist at Commerzbank, says it is clear where the market thinks the problem is in Europe and should Berlusconi finally resign, this would provide support for the euro.

“The FX market made its point of view more than clear: Berlusconi has to go.”

That said, it is far from clear that the rise in Italian bond yields, which notched up a fresh euro-era high on Monday, will be stemmed by Berlusconi’s departure.

As Karpowitz notes, the Italian opposition has not exactly been known for its ambitious savings programmes.

As bond yields rise, financing costs on Italy’s debt rise and threaten to put further pressure on the country’s public finances. This clearly is an issue for Italy, which is sitting on nearly $2 trillion of long-term debt.

Italy is, of course, better positioned than, say, Greece to cover its refinancing costs.

Indeed, unlike the bailed-out nations of Europe, Italy has not run into financial difficulties as yet: Rome still has a primary budget surplus and so can pay its bills and, unlike Greece, can afford public sector spending for this year.

But analysts say it is Italy’s long-term debt that is the problem and one that is unlikely to be addressed by a change in government.

“The collapse of the Berlusconi government could cause a relief rally in the euro, Italian debt and stocks,” says Kathleen Brooks, research director at Forex.com.

“However, this is unlikely to last as markets realise that the opposition may not be any more effective than Berlusconi.”

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