03.10.201800:43 Forex Analysis & Reviews: EUR/USD: the recalcitrant Italians drown the euro

The narrative around the state budget of Italy for the next year continues, putting strong pressure on the European currency. The EUR/USD pair fell to 1.5 – month lows, currently testing a strong resistance level of 1.1520, which is the lower limit of the Kumo cloud on the monthly chart. If the price is fixed under this level, the pair will soon enter the 14th figure, confirming the dominance of bears on the pair.

Despite the fact that the proposed draft Italian budget does not violate the EU requirements in terms of the permissible size of the deficit (not more than three percent), it caused an uproar in Brussels. The EU leadership has strong arguments for its discontent: if last year the Italian authorities laid the budget deficit at the level of 1.6%, now they want to raise this bar to 2.4% at the previously agreed 0.8%. And this is despite the fact that the size of Italy's public debt is one of the highest in the eurozone (here the Italians are second only to the Greeks), and the unemployment rate in some areas of the country reaches 30 percent. But these facts do not confuse politicians who recently came to power on the wave of populist promises. Now they have to fulfill (at least partially) their promises – at the expense of "inflating" the budget.

It is worth noting that the political events in Italy are unfolding quite dynamically – in the last five years the country was led by four prime ministers. None of them held office for more than two years. Representatives of the current coalition are well aware that time is playing against them, and if Brussels wins the "budget battle", their positions will weaken in many ways. That is why the Italian deputy prime minister said today that he will not back down "one iota" from those expenses that were planned in the scandalous draft budget. In particular, we are talking about an increase in pensions and social benefits. In addition, representatives of the "League" want to carry out next year's tax reform by changing the tax rate on personal income: 15% for households with incomes less than 80,000 per year and 20% for those whose income exceeds this level.

These intentions are opposed by Brussels and Italy's Minister of Finance – practically the only influential "opposition" in the current government. In his opinion, the maximum allowable size of the budget deficit is 1.9%, but not the declared 2.4%. He also recalled that the Italian national debt exceeds 130% of GDP (2.3 trillion euros), and the actions of politicians offset the work on reducing the debt burden. It is noteworthy that to date Italy's budget indicators are consistent with the European Union, according to which the deficit was to be reduced from 1.6% of GDP this year to 0.8% in 2019, and in fact to zero in 2020. Now Rome shows the opposite trend - instead of the previously agreed 0.8%, it proposes to set the bar at 2.4% of GDP.

Such a sharp turn provoked a strong reaction from Brussels. According to the Italian press, if Rome implements the stated scenario, the European Commission will reject the draft budget and even consider the issue of applying sanctions against Italy. It is worth noting that we are talking about a fairly broad time frame: until October 20, members of the Italian government must approve the draft budget (in one form or another), before the end of November, this budget will be considered by the European Commission, and the sanctions procedure can be implemented at the beginning of next year. Therefore, if Rome decides on the declared budget deficit, the European currency will be under pressure for a long time.

In general, the EUR/USD pair reacted quite cautiously to the Italian event, until one of the ECB representatives commented on the situation. Thus, the head of the Bank of Finland Olly Ren said that the plans of the Italian government are alarming, and now the regulator is likely to "carefully monitor the risks." Obviously, if the Italian crisis worsens (especially if the European Commission returns Rome's unapproved draft budget), then at the next meeting of the ECB (October 25), the regulator will significantly soften its rhetoric, thereby putting additional pressure on the euro.

The current situation has its consequences, and not only in the context of the foreign exchange market. In particular, the Italian stock index FTSE MIB lost 3.7% amid a selling of Italian government bonds. If panic increases, this trend will continue.

However, in my opinion, the Italian crisis will end quite quickly when a certain peak is reached. Most likely, a compromise will be reached, assuming a reduction in the budget deficit under the two percent mark. On the one hand, Brussels will avoid a political crisis in Italy, and, on the other hand, Italian politicians will be able to partially fulfill their election promises, and the responsibility for the unfulfilled part will be transferred to the shoulders of the European Union, "which did not allow them to implement their plans." From a political point of view, this is a fairly convenient and "safe" position, so it will be surprising if Italian politicians show excessive principledness on this issue.

From a technical point of view, the euro-dollar pair has reached an important support level of 1.1520 (the lower limit of the Kumo cloud on the monthly chart). If bears push this mark, then the next support level will be the mark of 1.1440 (the bottom line of the Bollinger Bands indicator on W1).