World First Morning Update 9th November 2011: The Italian Sob

So Silvio Berlusconi is set to resign his post as Italian Prime Minister and markets have rallied overnight on the belief that a new leader will be able to give some credibility to the country’s austerity and reform activities. Berlusconi will not go immediately but instead will stay in position until the 2012 budget and related austerity measures are passed by parliament. This was already scheduled to be the end of the month although we may see this brought forward so as to head the bond markets off at the pass.

The yields on Italian debt have continued to rise over the past 24 hrs with the 10 yr hitting as high as 6.74% yesterday which are fresh euro-area highs. Remember that as and when the Greek, Portuguese and Irish bond markets got to 7% we saw the IMF step in and bailouts were forced upon them. It took on average 16 days for yields to move from 6.5% to 7% in these instances and we are now into day 3 for Italy. The rise may be slowed by ECB purchases of Italian debt but there does seem to be a semblance of inevitability about these moves.

We have not seen a massive shift in favour of the euro however in the aftermath of the announcement. We saw EUR/USD jump by about 75pips and GBP/EUR slipped by around 40 although most of these have been given back after an announcement from LCH.Clearnet (a clearing house of Italian debt) that they are increasing the amount of deposit needed to trade Italian debt from 6.65% to 11.65%. What this means is that people wishing to buy Italian debt, including the ECB, need to put down cash or collateral of 11% to the value of the debt they are purchasing. This will naturally reduce the amount of debt that some market participants can purchase and yields will unfortunately rise.

The rise in equities and risk overnight has also come as a result of better than expected inflation data from China that showed the increase in prices to be at slowest since February 2009 which may lead the PBoC to loosen monetary policy. China, for all its strength, is also experiencing problems as a result of the European debt crisis and a potential downturn in the property market and it is widely believed that some form of monetary easing may be in the pipeline so as to stimulate consumer and business demand moving forward.

In UK news we saw UK manufacturing output rises for the first time in 4 months. While this will have a relatively negligible impact on UK GDP growth going forward it certainly will not be acting as a weight around the UK’s neck. Manufacturing data has been iffy of late and more forward looking measures such as the PMI series have suggested that a slight slump is around the corner and we would expect this to show its head in Q4. This will further solidify the Bank of England’s monetary policy posture as ‘ultra-loose’ moving through the beginning of 2012. The pound remained unchanged after the announcement.

Today will see more rumour and intrigue around the Italian debt and political situations while the Bank of England starts its 2-day meeting on interest rates.

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