14.07.202223:47 Forex Analysis & Reviews: Euro choked by Italy

Trouble doesn't come alone. In addition to the energy crisis, increased risks of a eurozone recession, and an increase in the number of COVID-19 infected in the eurozone, another problem has been added for EURUSD bulls. Another political crisis may break out in Italy, which will become another headache for the European Central Bank in the decision-making process on the speed of raising the deposit rate.

The third economy of Europe, even at the time of the creation of the currency bloc, caused fears in Germany. A debt-ridden country could become the destroyer of an entire community that had to live by its own rules. Too tough for Rome. A lot of water has flowed since then. In Italy, ten prime ministers and 14 governments have been replaced. It would seem that the coming to power of ex-ECB head Mario Draghi, before whom the whole of Europe bowed its head, was supposed to stabilize the situation. So it was at first.

Nevertheless, as soon as the main coalition partner, the Five Star Party, refused to support the prime minister's proposal to provide subsidies to enterprises affected by rising energy prices, Draghi's fate hung in the balance. He threatens his resignation, which causes a wave of panic in the financial markets. The yield spread of 10-year Italian and German bonds, a key indicator of political risk in Europe, is soaring up, which in the past had a negative impact on EURUSD.

Dynamics of the Italian and German bond yield differential

Naturally, the ECB should intervene. But if it fails to cope with the task of closing spreads or goes too far with a rate hike, or a political crisis breaks out in Italy, including early parliamentary elections, the euro will continue its protracted peak against the US dollar.

In fact, the regional currency faced all the problems at once, including the devaluation of 1999, the financial crisis of 2008, Greece's intention to withdraw from the eurozone and the pandemic of 2020. Should we be surprised by the collapse of EURUSD? Especially since the US dollar, with its aggressively anti-inflation Federal Reserve, is so strong.

Scenarios for the growth of Italian public debt

It is clear that the weakening of the euro is not at all what the ECB wants to see. Not only does it contribute to the acceleration of inflation due to the rapid rise in import prices, it also aggravates the energy crisis. Enterprises have to pay more for gas, their costs are rising, their incomes are declining.

To solve the problem, the central bank has two options: either start raising the deposit rate more aggressively than currently expected, or use foreign exchange interventions. The last time the ECB intervened in the life of Forex was at the end of 2000, when the euro was worth $0.85.

Technically, on the 4-hour EURUSD chart, after a clear development of the strategy presented in the previous article, the Expanding Wedge pattern begins to form. A necessary condition is the bears' inability to take quotes below 1 for a long time. We sell on a breakout of 0.9995, when the pair returns to 1.01, we buy.