Currency watch: Italy smashes through critical 7% barrier

What took Greece, Ireland and Portugal an average of 16 days has been taken care of in just 96 hours by the Italians.

Yields on government debt over a 10 year timescale smashed through the 7% level this week, with little resistance from the European Central Bank (ECB) which has been buying Italian debt so as to try and reduce the yield.

Unfortunately the rumoured €250 million purchase of debt was completely drowned out by the political problems in Europe and the belief that – with Italy in the same situation as Greece, Ireland and Portugal – the EU as a whole has crossed the point of no return.

The markets continue to lurch from one problem to the next and we have now kicked the can as far down the road as is possible. There is very little more that can be done to stop this crisis. The only possible mechanism for the Eurozone to haul itself out of this mess is to let the ECB print euros and print them like their life depends on it, because – and I don’t mean to sound flippant – the euro’s life does depend on it.

In UK news we saw UK manufacturing output rises for the first time in four months. While this will have a relatively negligible impact on UK GDP growth going forward it certainly will not be acting as a weight around the UK’s neck.

Manufacturing data has been iffy of late and more forward looking measures such as the PMI series have suggested that a slight slump is around the corner. We would expect this to show its head in Q4. This will further solidify the Bank of England’s monetary policy posture as ‘ultra-loose’ moving through the beginning of 2012. The pound remained unchanged after the announcement.

When we’re not chasing rumours and following the unfolding crisis in Europe, there was also some key structural data out this week, to distract us, featuring some fairly major monetary policy decisions at that. No change in policy or policy statement was expected after the surprise unanimous decision at the October meeting to increase asset purchases by £75bn over four months to £275bn.

The minutes of the MPC meeting showed that the committee understood that the UK recovery was under threat, from the lack of growth in Europe and elsewhere in the world and the effect that this will have on the banking system and liquidity.

Focus within next week’s quarterly Inflation Report will be on the Bank of England’s outlook for the CPI taking into account the latest round of asset purchases. We expect no change from the Bank of England and very little sterling reaction. There will be a lot of movement in GBP/EUR and GBP/USD, however, as a result of the risks posed by Europe. USD strength is looking very likely to continue while Europe’s problems will continue to act as an albatross around the single currency’s neck.

Jeremy Cook is chief economist at World First foreign exchange