We had several negative factors affecting the EUR today, which came under heavy pressure in the European session, especially against the USD, JPY and AUD. The EUR/USD , after having tested the 1.4530 area at the beginning of the global session, fell down to 1.4385 before stabilizing.

The negatives for the EUR were:

  1. S&P warning about a possible double dip in Europe.
  2. Warnings from a Bank of Italy official that Italy's slow growth will make it tougher for the country to meet its deficit reduction targets.
  3. The European Commissions euro-zone economic sentiment came in weaker than expected, increasing concerns about growth.
  4. An Italian auction of debt - which we previewed here - was poor, causing yields in Italy to climb.

1. Risk of Double Dip in Europe Growing S&P Warns - We had seen speculation about the possibility of a double dip in Europe pick up pace following the weak 2nd quarter GDP reading we saw a few weeks ago. With the core countries of Germany (0.1% q/q growth) and France (flat growth) during the quarter, and a pick up in the sovereign debt crisis to begin the 3rd quarter, there are real concerns that the economy will begin to contract.


From CNBC: High unemployment and the recent decline in stock markets pose a risk to spending, rating agency Standard & Poor's wrote on Tuesday in a report headlined 'Slowing Growth in Europe Increases the Risk of a Double Dip.'

Downside risks are significant and the rating agency will closely monitor trends in consumer demand in the coming quarters, Jean-Michel Six, Standard & Poor's chief economist for Europe, said in the report.

We continue to believe that a genuine double dip will be avoided because we see several sources of continuing growth over the next 18 months, including still buoyant demand from emerging markets and an ongoing recovery, albeit sluggish, in corporate capital spending, Six added.

2. Italian Austerity Measures Can Cut Italy's Growth to Less than 1% - Italy was in the spotlight today as Bank of Italy director general said that the austerity measures that have been passed by Italy can limit growth which would make it more difficult for the country to cut its deficits and will add strain to the country's borrowing costs (see #4).


The plan for Italy is to bring the deficit to -3% in 2012, and to balance the budget in 2013.

From AGI: Italy's GDP growth rate could be less than 1% in 2011. The warning was launched by Bankitalia's Deputy Director General, Ignazio Visco, during the hearing on the emergency budget before the House and Senate joint Budget Commission. A predictive projection that remains highly uncertain - Visco explained - could show GDP growth to be less than 1% this year and even lower in 2012″

From AGI: Ignazio Visco said that the budget cuts will inevitably slow the economy. The deputy director general of the Bank of Italy explained: The adjustment of accounts, necessary to avoid a far more serious scenario will inevitably have restrictive effects on the economy. He made the point during the joint hearing of the budget committees of the House and Senate, adding that, For many years economic growth in Italy has been lower than that of other European Union countries.

We also saw the Italian government paring that austerity plan, taking away the extra solidarity contribution or tax that was extremely unpopular in the country.

From FT: Italy's centre-right coalition is to revise radically a tax on high incomes introduced as part of the €45.5bn austerity package passed by the cabinet two weeks ago, in an attempt by Silvio Berlusconi, prime minister, to win back support for his ruling majority.

The cancelling of the so-called solidarity contribution for everyone but national legislators is to be balanced with new fiscal measures to combat tax evasion and the reduction of tax breaks for co-operatives, said a statement issued after a long meeting between Mr Berlusconi, Giulio Tremonti, his finance minister, and Umberto Bossi, leader of the Northern League and a close government ally.

3. Economic Sentiment Declines - The European Commission's economic sentiment indicator showed the deterioration in economic conditions that have accompanied the financial market turmoil over the summer in Europe. This does not bode well for European growth for the 3rd quarter.


From the Release: In August, the Economic Sentiment Indicator (ESI) declined by 5.0 points to 97.3 in the EU and by 4.7 points to 98.3 in the euro area. This decline resulted from a broad-based deterioration in sentiment across the sectors, with losses in confidence being particularly marked in services, retail trade and among consumers. Only the construction sector in the euro area recorded an improvement.

From Wall Street Journal: Euro-zone businesses and consumers were significantly less confident about their prospects than expected in August, stoking fears that the currency area's economy is stalling and may even be heading for its first quarterly contraction in more than two years.

The index is now consistent with annual gross domestic product growth of about 0.7%, implying that activity could fall outright in the third quarter compared to the second quarter, Jennifer McKeown, an economist at Capital Economics, said in a note. Quarterly euro-zone GDP growth slowed to 0.2% in the second quarter from 0.8% in the first.The index is now consistent with annual gross domestic product growth of about 0.7%, implying that activity could fall outright in the third quarter compared to the second quarter, Jennifer McKeown, an economist at Capital Economics, said in a note. Quarterly euro-zone GDP growth slowed to 0.2% in the second quarter from 0.8% in the first.

The sixth consecutive monthly decline in the headline index also suggests the European Central Bank would be unwise to raise its benchmark interest rate for a third time this year even though inflation remains above its target.

4. Italian Auction Considered Poor: An Italian debt auction of 10-year as well as 3- and 5- year bonds saw lower borrowings costs than in previous auctions thanks to the ECB's bond buying efforts which have brought down yields for the country, but the demand for the auction - its bid to cover ration - was weaker than expected, and that caused unease in periphery bond markets.

Here's a look at Italy's 10-year yield in today's session:


From New York Times: Despite a backdrop of weakening growth in the euro area, Italy was able to sell a slice of debt Tuesday at a lower interest rate.

On Tuesday, the Italian Treasury sold €3.75 billion, or $5.4 billion, of 10-year securities at 5.22 percent. That compared to a rate of 5.77 percent at a sale of similar bonds in late July.

Demand at the auction was 1.27 times the amount on offer, down from the level at the last auction of 1.38 times. The Treasury also sold €2.99 billion of bonds maturing in 2014.

Italy is still able to fund itself at 'market rates' but those are being artificially depressed by the E.C.B.'s bond buying, said Eric Wand, an interest rate strategist at Lloyds Bank Corporate Markets in London.

From Reuters: Italy returned to bond markets on Tuesday with a 7.74 billion euro sale that met relatively weak demand despite the ECB buying Italian debt in recent weeks, sparking a nervous reaction among investors.

Signs of lower-than-expected demand at the auction - awaited as a crucial test of emergency steps taken to stem the spread of the euro zone debt crisis - pushed Italian bond yields higher and sparked a rally in safe-haven German debt immediately after the sale.

Traders said the European Central Bank stepped in after the auction to buy significant amounts of 10-year debt, bringing yields back down.

The results look a bit worse than the market was expecting, with the 10-year looking weak with a rather small bid cover ratio, said Credit Agricole rate strategist Peter Chatwell.

Nick Nasad
Chief Market Analyst