Euro sinks after Italian borrowing costs soar

USD

The dollar strengthened as risk appetite plummeted on deepening Italian debt fears and investors sought a safe-haven for their money. Political uncertainty in both Italy and Greece also took its toll after Italian Premier Silvio Berlusconi rejected the idea of forming a coalition government, opting instead to step down after fiscal reforms have been implemented and let elections decide the next administration, a move widely seen as more risky for the economy; and as a result Italian borrowing costs rose ever higher, breaking the 7.0% ceiling of sustainability on Wednesday morning. There is now serious concern that Italy will default and require a bailout from the E.U and IMF, although given its economic size and the magnitude of its 1.9tr debts there is less hope of sufficient funds being found to plug the hole. The dollar benefited the most from the market turmoil after the attractiveness of both the yen and the Swiss franc have been tarnished by intervention. Eurodollar fell from consolidation range in the 1.37s to the 1.35s. The light economic docket for the day meant news from Europe dominated, although MBA Mortgage Applications rose by 10.3% vs 0.2% in the previous week and Wholesale Inventories fell by -0.1% when a rise to 0.5% had been expected.

EUR

The euro collapsed on Wednesday after concerns that Italy might default on its massive debts plagued the single currency and investors sought instead the peace of mind offered by assets denominated in the world's reserve currency. Soaring Italian borrowing costs were the main cause of the fall after they pushed above the 7.0% mark on the benchmark 10-year bond – a level over which the Portuguese and the Irish were forced to call on E.U and IMF help when their costs ran high earlier in the crisis. The ECB was reported as buying large numbers of Italian bonds in an effort to stem rising yields but the tactic was not seen as a long-term solution to the problem. Despite international calls for decisive action there was little response to the escalating problem except tentative talk of a deeper integration of the core element of the E.U, into something more resembling a super-state, however, this would require a long gestation and is almost unrealistic both practically and politically. There was also further rumours of the EFSF being leveraged but nothing concrete. The euro may head lower now as Italy is targeted as the next lame duck by the bond markets and there is no telling what the effect will be if the situation gets worse and the E.U is called on to bailout such a large economy.

GBP

The pound fell heavily on Italian debt fears after borrowing costs soared above what are considered sustainable levels and sterling suffered due to Europe being its closest trading neighbour and the high exposure of U.K banks to peripheral debt. Against the euro sterling faired better as its economy is seen as more secure than the euro-zone and the government's unswerving commitment to austerity reforms praised by the markets. The BOE's increased monetary easing has not impacted as heavily on the pound as perhaps previously expected and many widely expect the ECB to follow its lead and cut interest rates at the very least. Despite being overshadowed by events in Europe there were some important data releases for the pound including the Visible Trade Balance which showed a larger than expected increase in the deficit to -£9814m pounds vs -£8000m; Total Trade Balance which fell to -£3940m compared with -£2100m and Trade Balance Non-EU which also fell to -£5715m vs -£4950m but underlined the UK's close links with the E.U given it accounted for over 50% of the total.

JPY

The yen rose against riskier currencies after risk aversion increased following renewed debt problems in Europe with the focus this time shifting to Italy. To a certain degree investors overcame their fear of intervention to buy the yen for its safe-haven qualities again although its gains were not as dramatic as they had been before the last intervention. Commentary from a senior BOJ official emphasised the possibility of more monetary easing as high on the agenda given the myriad of challenges faced by the Japanese economy, including March Earthquake, the super-high yen, slowdown in global economy and now the floods in Thailand. Further intervention also remains a distinct possibility given the willingness of the administration to use it. On the data front ?yen was supported by better than expected figures, including Trade Balance, which showed an above average rise in the surplus to 373.2bn yen vs estimates of only 351.7bn; the Adjusted Current Account showed a rise to 1186.6bn vs 963.2bn expected; Bank Lending improved – primarily due to rebuilding work after the Tsunami - by 0.1% when a fall of -0.1% had been forecast and on Wednesday Japanese Bankruptcies fell by -14.1% in October compared to -9.2% in the month before and the Eco Watchers Sentiment Surveys fell both for Current – 45.9 vs 46.5 expected and Outlook 45.9 vs 46.4 previous.