Forex Flash: Political drama unfolds across Europe – Deutsche Bank

January's are virtually always risk-on so that took care of itself, however February had the build-up to the Italian elections and our expectations for the first risk-off period for the year. Well no-one could have also predicted the political drama unfolding in Spain and that has played a big part but together events in Italy and Spain are a reminder of how dependent they are on political cohesion to ensure that the ECB fire break can be activated smoothly if needed. According to Macro Strategy Analysts J. Reid and C. Tan at Deutsche Bank, “A political vacuum or worse still a change in direction will make any future ECB intervention more difficult.”

For the record the most likely outcome in Italy remains for a pro-reform agenda to be elected and for the market to eventually regain its poise in March but the uncertainty will linger until the elections on February 24/25th. The uncertainly is not being helped by the steadily improving support for Berlusconi just a few days before the opinion poll black-out that starts on the 9th (Saturday).

We then enter a black-hole where no-one will be sure whether the momentum has continued. So we do think markets might struggle a bit until this is out of the way. So a few weeks of mild risk-off was always our thought for February and continues to be now. “On the Italian elections it's worth reminding readers of our European economists' latest Focus Europe piece which highlights that although a coalition between the center-left and Monti's centre remains most likely, a slim majority could slow Italy's reforms.”