European currencies (bar GBP) have all have made decent gains versus USD, JPY and to a lesser extent CHF in the past 24 hours.
EUR/USD is back above 1.16, but still within touching distance of yesterday’s 10-month low, following reports in the local press that League and the Five Star Movement (M5S) are in talks to agree a new government (option 1), but that both parties could also back a so-called caretaker government if the discussions fail so long as fresh elections are held by September or October (option 2). A third option is a separate coalition led by the centre right but that also features parties from across the political spectrum.
All three options would likely offer the Euro further relief near-term. But options 1 and 2 in particular may not provide a satisfactory or final answer as to whether a League-M5S coalition, if able to form a government, would ultimately seek take Italy out of the Eurozone and in the process default (partly or in full) on its Euro-denominated public debt.
Italy’s debt dynamics are not favourable and will have deteriorated further as a result of surging Italian yields. But again the real issue is likely to be any new Italian government’s willingness to service its debt and by extension its willingness to keep Italy within the Eurozone. Until that question is answered the fundamental risk is that the Euro remains under pressure.
