May 17, 2018 / 7:35 AM / 10 months ago

Daily Briefing: Italy - Eurozone braced for next challenge

LONDON (Reuters) - Italy's 5-Star Movement and the League are now seen close to signing off on a radical government pact that will set Rome up for a likely showdown with the European Union over spending plans that will bust the eurozone's deficit rules.

Duomo's cathedral and Porta Nuova's financial district are seen in Milan, Italy, May 16, 2018. REUTERS/Stefano Rellandini

The Italian economy is the third largest in the eurozone and almost 10 times the size of Greece’s: make no mistake that this is a potentially a big new challenge to the stability of the euro in the making.

Roadblocks to government formation still exist: The two parties still need to find a candidate for prime minister, and will seek the backing of their supporters in informal ballots at the weekend.

Once these hurdles have been overcome, they will need the blessing of President Sergio Matteralla, who has made clear he does not want to see Italy break with Europe.

The Telegraph reports that Britain will tell Brussels it is ready to stay in the European Union's customs union beyond the 2021 transition deadline if the technology required to operate complex new borders plans is not ready in time.

It adds that officials warn it may not be in place until 2023. If true, this starts to looks very much like one of those slippery slope scenarios when the final date for leaving the customs union starts to move ever further beyond the horizon. Sterling has risen against the euro this morning on the hopes of some investors that this will be the case. No official comment is forthcoming from Downing Street.

Meanwhile the European Union holds its first summit with Balkans membership hopefuls in 15 years.

All the rage in the couple of decades after the fall of the Berlin Wall, so-called enlargement of the bloc to new nations has since dramatically slowed amid concerns that the EU has yet to fully digest its newest members and growing voter hostility in some quarters to cross-border migration.

While the EU is a long way from firm promises of membership to any of the six nations present, it will seek to persuade them that this can be a long-term goal if they pursue the necessary political and economic reforms.

What it wants to avoid at all costs is them falling into the embrace of Moscow.


U.S. Treasury borrowing rates continue to surge first on Thursday, adding stress to bond markets around the world and keeping the dollar pumped up too.

Ten-year Treasury yields hit a near 7-year high of 3.12 percent – a jump of more than 12 basis points in just three days – as U.S. retail sales numbers were the latest to show the brisk expansion continuing stateside and as Brent crude oil hit another 3-1/2 year high just shy of $80.

While the 2-year yield hit its highest since 2008, the 2-10-year yield curve is steepening and hit 52 basis points for the first time in about three weeks.

The dollar index was higher first thing, even if off its best levels from Wednesday.

Euro/dollar is struggling to keep a foothold back above $1.18 and dollar/yen hit its highest level since late January at 110.57. Sterling bucked the trend, rallying against both the dollar and the euro after a UK newspaper reported that Prime Minister May would tell Brussels that Britain was prepared to stay in the European Union’s customs union after a transitional arrangement beyond 2021.

The other two big macro market spotlights stay on Italy and Turkey.

Benchmark Italian government bond yields nudged higher after a 16 basis point jump on Wednesday following reports, subsequently denied, that the prospective Five Star/League coalition government had drafted an economic plan that would seek 250 billion of debt forgiveness from the European Central Bank.

While few people see that as either a realistic proposal or one that would remain in the coalition’s agenda, the tone of the new government’s stance toward euro zone rules was seen as confrontational and spooked some investors.

Markets now eagerly await the final agreement to see what details remain in there.

Two-year Italian government yields moved into positive territory on Wednesday for the first time in almost a year – the only other positive yielding  two-year government bond is Greece.

That said 10-year Italian yields are now only back to levels seen around the election in March and still remain remarkably calm given the 10 week government hiatus.

In Turkey the lira resumed its steep slide first thing after a brief stabilization Wednesday when the central bank warned it would take action.

In the absence of that, however, one of the main concerns is that President Erdogan has stated he plans to take more control over monetary policy after next month’s elections – questioning the independence of the central bank and unnerving those who are puzzled by Erdogan’s stated belief that lower interest rates brings lower inflation.

Erdogan met with the central bank chief on Wednesday, but there’s been no read out from that meeting. In equities, Wall St closed higher last night but futures are on the backfoot given rising Treasury yields.

Slideshow (2 Images)

Asia bourses were mixed, but MSCI’s all-country index was in positive territory.    

European stocks were flat to positive, with Italy’s blue chips recovering some of Wednesday’s lost ground.

 A look at the day ahead from European Economics and Politics Editor Mark John and EMEA markets editor Mike Dolan. The views expressed are their own.

Editing by Matthew Mpoke Bigg

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