The single European currency has been losing ground against the US dollar for nearly five weeks. The main reason behind such protracted weakness is a political crisis in Italy where a coalition government has to be formed for the first time in the modern history.
Italy is the third largest economy in the euro area and one of the countries which founded the EU. No wonder the euro is highly sensitive to any developments in Italy. Political uncertainty raises concern among investors that dealt a blow to the euro. In mid-May, the euro shed almost 1.2% versus the US dollar. Besides, it slumped versus the Swiss franc as demand for safe haven assets increases in time of turbulence. Leader of the 5 Star Movement Luigi Di Maio and Matteo Salvini who is at the helm of the League made a coalition agreement to challenge restrictions of the EU on government borrowings and expenditures. The EU imposes restrictions on a state budget deficit (3% of GDP) and a public debt (60% of GDP). The EU authorities require governments to ensure a well-balanced budget. EU countries are banned to amend these rules unilaterally. In case of a precedent, other countries could also reconsider such things. Interestingly, having a significant sovereign debt, Italy’s would-be government intends to ask the EU lawmakers for a relaxation of deficit rules.
In fact, Italy’s huge public debt accounts for 132% of GDP. Moreover, investors are discouraged with sluggish economic growth. So, they have obvious reasons to worry that a 5 Star/La Lega coalition will reduce Italy’s commitment to the European Stability and Growth Pact.
