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The Italian Upset and the Euro

Silvio Berlusconi
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Silvio Berlusconi

Just when you thought the Good Ship Italy was righting itself, along comes Silvio Berlusconi to roil the waters.

The disgraced former prime minister appears to have had a surprisingly strong showing in the Italian elections, which appear to have no clear winner, and experts are now saying Italy could be facing a hung government or even a new election. Not surprisingly, the confusion is pulling the euro lower.

So what's the best move from here for currency traders?

"I think the election results (or lack thereof) are a negative for the euro, which will likely keep the currency pressured for some time," Omer Esiner, chief market analyst for Commonwealth Foreign Exchange, told me. But it's not just the political uncertainty in Italy, he adds. "The shocking gains made by anti-establishment parties in Italy signal a broad-based frustration with austerity among voters and a decisive rejection of the policies pushed by Germany in nations across the euro zone's periphery. That theme revives unresolved debt crisis issues and could threaten the continuity of reforms across other countries in the euro zone."

In other words, to the extent that Italian voters are giving voice to anti-austerity feelings that exist throughout the euro zone periphery, then it's not just Italian reforms that are at risk.

Alan Ruskin, global head of G10 FX strategy at Deutsche Bank, says the Italian election results will benefit the dollar.

"Everything that has happened will tend to play USD positive on a multi-month basis," he says, provided bearish fundamental pressures on the yen, British pound, and Canadian dollar are not changing, since "the EUR has largely excluded itself as a possible alternative to the USD as a medium-term long versus these currencies."

Kathy Lien, a managing director at BK Asset Management, has some price targets for the euro. She wrote in a note to clients that if Pier Bersani, the center-left candidate once widely expected to win the election, comes in third behind Berlusconi and the comedian Beppe Grillo, "we expect the EUR/USD to fall to 1.30. Even if he wins, it is hard to imagine that the market will cheer his slim victory. We don't expect the Italian election results to drive the EUR/USD to 1.25 but it could have a bit more impact on the euro before the focus shifts and investors move on to growth and ECB monetary policies."

But Steven Englander, head of G10 FX strategy at Citigroup, has looked back at Berlusconi's tenure as prime minister, and scandals aside, he is more sanguine. "Considering that euro spent months happily over 1.40 with Berlusconi as PM, this is a set back but not a catastrophe," he wrote in a note to clients.

True - but for now it seems to be time to say "ciao" to Italian stability.

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