Concern over Italy’s budget are overwrought. The government in Rome has passed a budget with a 2.4% deficit relative to GDP – slightly higher than expected, considerably higher than 1.6%-1.8% recommended. Euro Stoxx 50 are lower while EUR/USD has fallen 1.40% to 1.1620. Italian bond yields continue to rise. We suspect that lasting effects will be limited and expect the euro to recover.
First, the European Central Bank is still active in the bond markets that provide support. Markets should not underestimate the ECB’s conviction to maintain European stability. Let’s not forget ECB President Mario Draghi's famous speech on 26 July 2012 over the 'irreversibility' of the euro and ECB's readiness to do 'whatever it takes' to preserve the euro. Second is the global relevance of budget deficits. It been a long time since markets really cared about maintaining a balanced budget, so why should this matter in Italy? Aggregate eurozone has an 86% debt to GDP, just slightly above the UK’s. And then there is the USA’s swelling deficit. As investors turn their attention to the Ryder Cup (Europe will not hold their early lead), the euro will recover.
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