Euro breaks to new lows as Italian ‘No’ highlights political risks

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5 December 2016

Written by
Enrique Díaz-Álvarez

Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.

A fairly calm week in FX markets came to a sudden end on Sunday, as Italians soundly rejected the proposed political reforms in a referendum.

hile the ‘No’ result had been expected by markets, the magnitude of the defeat for the Italian establishment was much larger than even the most pessimistic polls had predicted, prompting Prime Minister Renzi’s resignation and bringing forth the prospect of new elections and a possible victory for Eurosceptic parties.

The reaction in markets was immediate and sharp. The Euro hovered near 20 month lows, with Sterling down about 0.5% against the US Dollar and up a similar amount versus the common currency.

The key question for markets now is whether elections follow in Italy. If so, they would be added to a calendar that is already crowded with political risks. This is by no means a favorable prospect for the Euro and we reiterate our forecasts for a break below parity at some point in the first quarter of 2017.

Major currencies in detail


Sterling has had its best week in months.

Various conservative Government figures struck a more conciliatory tone towards European Union negotiations, emphasizing that retaining access to the single market will indeed be a key goal of the Brexit negotiations. We take particular comfort in Prime Minister May’s comments suggesting that the needs of UK businesses will be paramount in the conduct of the negotiations.

Overall, we remain comfortable with our out of consensus call that Sterling will rally towards 1.25 against the Euro by the first half of next year.


The resounding ‘No’ in the Italian referendum will unfortunately overshadow the rather positive news we had seen out of the Eurozone economy over the past few weeks.

Last week we saw that unemployment finally broke through the psychological barrier of 10% in November. More importantly, the downward trend that seemed to have stalled in the summer has resumed convincingly.

At any rate, in the near term political risks will continue to focus both markets and policy maker attention. The defeat of the Italian establishment in the referendum comes at a delicate time. Italian banks are in the middle of a balance sheet clean up and recapitalisation process.

The ECB will surely try to play a constructive role at this point. We expect it to announce a time extension of at least six months for its assets purchase programme together with widening the pool of eligible assets.


The last remaining hurdle for a December Federal Reserve interest rate hike was cleared on Friday.

While the November payrolls report presented a contradictory picture, overall it is clear that the US labour market is still strengthening. Both the headline number and the three-month average remained at just under 180,000 jobs created per month. Unemployment fell an unusually large 0.3%, to 4.6%. However, hourly wages actually dropped 0.1%, bringing the annual rate down to 2.5%.

We think both of these divergent surprises are statistical quirks and will be largely reversed in the coming months. Labour market strength and firming inflation pressures mean that the Fed is set to start increasing interest rates at a slow but steady pace, beginning with a 0.25% hike this month.