Political turmoil in Italy and the US has sent investors flocking to safe haven currencies such as the yen and the Swiss franc this morning. The news that Italy could be headed for its second general election in seven months sent the euro tumbling, while the continued squabbling over the US debt ceiling has also weighed on the dollar.
The election of Italian Prime Minister Enrico Letta seven months ago, which brought a degree of stability and pragmatism to the often tumultuous political landscape in Italy, calmed the markets and boosted the euro significantly. However, his lack of an overall majority meant that his Democratic Party (PD) had to form a coalition with former Prime Minister Silvio Berlusconi’s People of Freedom Party (PDL) amongst others. However, weeks of worsening relations between the two have culminated in Berlusconi pulling his five ministers out of the coalition.
The media mogul and former Prime Minister has been under investigation for tax fraud, and threatened to undermine the coalition if he was expelled from the Senate as a result of the investigations. Last week, his conviction was upheld, and a committee of the Senate is set to meet this week to decide his political fate. Despite this rather obvious incentive to disrupt the Italian political process, Berlusconi has claimed that the withdrawal of his ministers is the result of a disagreement over an increase in the sales tax to 22% – something that the normally mild-mannered Letta has described as a “huge lie” and an “alibi” for Berlusconi’s more obvious problems.
The unrest comes at a delicate time for the Italian economy, the third largest in the eurozone. The ruling coalition has been struggling to push through unpopular austerity measures, while the national debt has grown to around two trillion euros, nearly 130% of the country’s GDP. Any disruption to the plans for cutting the debt would send the interest rate on government debt up, making the debt mountain even more difficult to climb, and this is what happened over the weekend.
This caused the euro to fall very dramatically against other major currencies, including the US dollar. However, the fall against the USD was tempered by a political crisis unravelling across the Atlantic, and the EUR/USD pair is back within the 1.3470-1.3510 range it was trading for much of last week until a debt ceiling-fuelled surge on Friday.
With the deadline to extend the US government’s debt ceiling fast approaching, Republicans are using the standoff as leverage in an effort to sink President Obama’s healthcare bill. If a budget agreement is not reached by tomorrow, the US government could be effectively shut down, and this possibility is making investors very risk-averse.