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Italian games and German data (Daily analysis 8.10.2018)

8 Oct 2018 11:48|Marcin Lipka

The market notes over-optimistic forecasts for the Italian economy. Germany's industrial production declines for the first time in a year and a half. The weak global sentiment has a negative impact on the zloty. The euro returns to 4.31 and the dollar exceeds 3.75 PLN.

The most important macro data (CET - Central European Time). Surveys of macro data are based on information from Bloomberg unless noted otherwise.

  • A lack of macro data may noticeably impact the analyzed currency pairs.

Fear about Italy returns

The yields on Italy's 10-year Treasury bonds exceeded 3.60% in the morning. This is the highest level for more than four years. Investors clearly do not accept the macroeconomic estimates presented by the new Italian administration. In addition, the authorities in Rome want to confront Brussels. Given Italy's tight calendar (by the end of this week the budget will be sent to the European Commission, a review of Italy's rating will take place at the end of the month), the pressure on local assets may become more of a panic.

On Friday, the Ministry of Economy published official macroeconomic projections. They clearly show that GDP growth can be seriously overestimated. According to the new plan, it should reach 1.6% in 2020, although the main analysts are already revising downward their forecasts for the world. In the scenario of maintaining the economic policy from before the elections, expectations showed an increase of 1.1%. However, according to the original assumptions (already adjusted to the current economic situation), the fiscal deficit was supposed to be 0.7% of GDP in 2020 and the current coalition estimates it at 2.1%.

Everything points to the fact that the forecasts are strongly dialed up. The European Commission, which may still have official objections in October, will almost certainly not like it. The end of October is also a very sensitive moment for Italy because both S&P and Moody's are to review Italy's rating. The latter has already announced that creditworthiness is being analysed in the context of a downgrade. If the rating is cut, in the case of Moody's, it would be one point higher than the junk level. The discussion on the downgrade of Italy's investment rating when the ECB withdraws from purchasing government bonds (from the beginning of next year) could pose a serious problem for Rome. Therefore, the current increases in yields reflect the increased risks for the country.

Apart from Italy, the situation in Germany also looks unbelievable. In seasonally adjusted terms, Germany's industrial production fell for the third time in a row, this time by 0.3%. In addition, year-on-year production in August was also negative and dropped by 0.1%. This is the first decline since the beginning of 2017.

It is particularly disturbing that the production of capital goods (e.g. machinery and equipment for enterprises) decreased by as much as 3.1% y/y (minus 0.7% m/m). This is the worst result for over 4 years and the second weakest result since August 2013, when the eurozone was slowly recovering from the debt crisis. This may mean a slowdown in both the single currency area and the world. This is also negative news for the euro.

As a result, there is a dangerous mix of irresponsible policy in Italy and a weakening economic situation, which is damaging, among other things, the German economy. In addition, Rome is clearly beginning to adopt an aggressive policy before next year's elections to the European Parliament. Today, Matteo Salvini, leader of the coalition League, during a meeting with Marine Le Pen said that "we are against the enemies of Europe, i.e. Juncker and Moscovici". He also said that budgetary constraints are the continent's problem. Taking all the elements into account, it is no surprise that the euro is under pressure. It seems that the core scenario remains a further decrease in the EUR/USD, especially as the economic situation in the USA is better than in the eurozone.

Pressure on the zloty is still limited

The zloty remains under pressure from external events, but the zloty reaction is limited. The EUR/PLN pair is close to the 4.31 boundary. Last week's highs are exceeded at USD/PLN, where the dollar rises above the 3.75 level. At the moment, it is not visible that the situation of the Polish currency will drastically deteriorate.

Only a clear panic on Italian debt (e.g. increases in 10-year Treasury bonds up to the 4.00% level) could push the EUR/PLN pair to around 4.35 or cause the dollar to move well above the 3.80 level. This is unlikely to happen before the European Commission's decision on the Italian budget or the materialisation of concerns about Moody's or S&P lowering the rating of Italy.

8 Oct 2018 11:48|Marcin Lipka

This commentary is not a recommendation within the meaning of Regulation of the Minister of Finance of 19 October 2005. It has been prepared for information purposes only and should not serve as a basis for making any investment decisions. Neither the author nor the publisher can be held liable for investment decisions made on the basis of information contained in this commentary. Copying or duplicating this report without acknowledgement of the source is prohibited.

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