Problems in Italy and cuts in estimates (Daily analysis 9.10.2018)

Comments from Italian officials worsen the situation of the Italian government bond and have a negative impact on euro valuation. The IMF cuts economic growth forecasts for Germany. The zloty is weakening. Currently, the euro costs about 4.32 PLN and the dollar is approaching 3.80 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.

Pressure on Italy is getting stronger

Italy does not disappear from the headlines of the financial press. This may be partly due to the deliberate action of the government coalition. The opposing tone in relation to Brussels officials and meetings with other representatives of populist movements in the EU (yesterday the Deputy Prime Minister Salvini was at a joint conference with Marine Le Pen) are actions before next year's elections to the European Parliament. According to investors, this may increase the risk of confrontation with the European Commission in the context of the budget, and this fiscal irresponsibility may contribute to cutting the rating, which is scheduled to be reviewed by Moody's and S&P agencies at the end of October this year.

Apart from political events, it is worth noting that the Italian Finance Minister is using terrible arguments to withdraw the pension reform. Giovanni Tria stated that the current "pension system hampers the increase in employment". This was a reference to an absurd theory, which was also evident in Poland, that a low retirement age is good because retired people are giving up their jobs for younger people. It is not surprising, that in the face of such arguments, investors are getting rid of Italian bonds or are demanding a much higher premium for their purchase than in the case of a country with a stable economic policy.

There is also another interesting piece of information. Unfortunately for the Italian government, the IMF published new macroeconomic estimates a few hours ago. They show growth of only 1.2% this year and 1.0% next year. This is 0.5 percentage points less than the government's plans. Of course, GDP can be "boosted" with fiscal spending. Sometimes it brings positive results, especially when they are used to improve productivity. But will the market believe that lowering the retirement age and guaranteed income will improve the productivity of the Italian economy? Of course, the answer is negative, which perfectly depicts the behaviour of the Italian debt market.

The yields of Italy's treasury bonds maturing in 10 years increased to 3.70% today. This is 10 basis points more than yesterday's record - 80 basis points above the levels reached at the end of September and twice as much as the yields of these instruments at the beginning of April this year (1.8%).

Apart from the increase in Italian 10-year treasury bond yields to the highest levels since February 2014, the difference between Italian and German 10-year bond yields reached 3.17 percentage points and was the highest since April 2013. This perfectly shows the fear of the market about the Italian condition and at the same time the flow of capital to the safe haven, i.e. German bonds. All this puts pressure on the European currency as well. Today, the EUR/USD exchange rate fell below the 1.1450 boundary at midday, which brings the main currency pair closer to its annual lows.

The eurozone is not only deteriorating because of Italy. In its latest forecasts, the IMF has revised downward its growth estimates for Germany. It is expected to grow this year and next year by 1.9%. This is 0.3 and 0.2 percentage points less than expected in July. However, in the case of Germany it is not the fault of bad economic management by Berlin, but the result of the global slowdown and trade war. This does not change the fact that the eurozone economy looks much weaker than a few months ago.

Pressure on zloty may increase

The Polish currency remains under pressure from the events in Italy and worse economic conditions in the eurozone. The market, at a time of greater risk aversion, may also recall that over the last few years Warsaw has been increasing its fiscal spending instead of reducing it. On the other hand, a mild monetary policy is unlikely to defend the zloty's exchange rate against greater external pressure, which may at some point trigger a strong weakening of the zloty.

The aforementioned scenario is not the base one, but if the EUR/USD price were to be further reduced, then the zloty may also be under serious pressure. Increasing the yield on Italian treasury bonds to 4% will probably result in the EUR/PLN approach to the 4.35 level, and the dollar may even cost PLN 3.85. Yesterday, we pointed out that this scenario is unlikely until the end of the month, but today the pressure on the Italian debt suggests that this cannot be ruled out even in the next few days.