Date: 14 May 2018

Perhaps the most intriguing aspect of the prospect of a new coalition government in Italy,  which would comprise Luigi di Maio’s 5-Star party and Matteo Salvini’s League, both of which have espoused economic policies which seem inconsistent with the European Union’s fiscal rules, is how calm markets were about the possibility last week.  While the gap between Italian government bond (BTP) yields did widen out last week in comparison to their German government bond equivalents, the spread came in somewhat by Friday’s close.

However it remains to be seen how sanguine the BTP market will be going forward. After all, “We will need to renegotiate EU agreements to stop Italy suffocating,” Salvini said on Saturday. Markets might legitimately wonder how receptive the EU would be to any such renegotiation. In the currency space, any nervousness about Italy might be expected to lend itself to euro weakness. But against which other currency might that be expressed? EURUSD would be an obvious vehicle but, from an intra-Europe perspective, traders might also be inclined to take a look at EURCHF with the pair near the top end of its 1 year range. Traders might not think Italy will become a material driver of euro price action but it won’t hurt to think about what might occur if it does.

Written by Neal Kimberley, External Currency Analyst.