What's Driving The EUR Lower This Morning?

While everyone is focused on whether USD/JPY will break 100 this morning, we are much more interested in how this weekend's Italian Presidential election and ECB comments affect the euro. After five unsuccessful rounds of elections, Italy finally reelected Giorgio Napolitano as President. The 87-year-old politician is the first in Italy's to serve a second term in this role and the decision by the electoral college to bring back the old guard is a sign that the current political groups prefer to form a new government than to hold new elections for Prime Minister. The euro gapped higher on the news when the FX markets opened in Asia but since then the gap has been filled with the euro now trading lower against the U.S. dollar as concerns about ECB easing return.

Before we explain why the odds for ECB easing have increased, it is important to discuss Italy's political situation further as the decision on a president removes a major short-term destabilization risk for the euro. It is no secret that Napolitano prefers forming a government than hold elections and the fact that his reelection was supported a large coalition of parties is a sign that the political groups also want to avoid messy elections. Pier Luigi Bersani's inability to gather support for his two candidates forced him to resign as the leader of the Democratic Party. The PD now needs to nominate a new leader who will likely be more amenable to working with Napolitano. In fact local papers are saying that Napolitano agreed to a second term on the condition that the parties will work on forming a government. The re-election of Napolitano and the departure of Bersani gets Italy one step closer to resolving its political fiasco which should be great news for the euro.

Rate-Cut Support
However the EUR/USD is moving toward 1.30 this morning because more European Central Bank officials sound like they support the idea of a rate cut or some form of additional easing from the central bank. As we mentioned before, the ECB has a history of preparing the market for major changes in monetary policy through a consistent shift in tone by policymakers. Last week, Weidmann said the central bank could cut interest rates if new information warrants it and over the weekend, ECB member Asmussen also said the effectiveness of rate cuts is limited but its still possible to do this if data justified it. ECB member Knot repeated a sentiment shared by Central Bank President Draghi at the last monetary policy meeting. He said latest round of forecasts of the data coming in have shown that the risks are on the downside. As a result this week's euro zone PMI and German IFO reports will play a central role in setting expectations for ECB policy and help decide whether the EUR/USD maintains a break below 1.30.

There are no major U.S. economic reports today except for existing home sales, which scheduled for release later this morning. We don't expect this housing report to have power to drive USD/JPY above 100.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

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