httpvh://www.youtube.com/watch?v=jTk5zyH5v5c

So Silvio Berlusconi is set to
resign his post as Italian Prime Minister and markets have rallied overnight on
the belief that a new leader will be able to give some credibility to the
country’s austerity and reform activities. Berlusconi will not go immediately
but instead will stay in position until the 2012 budget and related austerity
measures are passed by parliament. This was already scheduled to be the end of
the month although we may see this brought forward so as to head the bond
markets off at the pass.

The yields on Italian
debt have continued to rise over the past 24hrs with the 10yr hitting as high
as 6.74% yesterday which are fresh euro-area highs. Remember that as and when
the Greek, Portuguese and Irish bond markets got to 7% we saw the IMF step in
and bailouts were forced upon them. It took on average 16 days for yields to
move from 6.5% to 7% in these instances and we are now into day 3 for Italy. The
rise may be slowed by ECB purchases of Italian debt but there does seem to be a
semblance of inevitability about these moves.

We have not
seen a massive shift in favour of the euro however in the aftermath of the
announcement. We saw EURUSD jump by about 75pips and GBPEUR slipped by around
40 although most of these have been given back after an announcement from
LCH.Clearnet (a clearing house of Italian debt) that they are increasing the
amount of deposit needed to trade Italian debt from 6.65% to 11.65%. What this
means is that people wishing to buy Italian debt, including the ECB, need to
put down cash or collateral of 11% to the value of the debt they are purchasing.
This will naturally reduce the amount of debt that some market participants can
purchase and yields will unfortunately rise.

The rise in equities
and risk overnight has also come as a result of better than expected inflation data
from China that showed the increase in prices to be at slowest since February
2009 which may lead the PBoC to loosen monetary policy. China, for all its strength,
is also experiencing problems as a result of the European debt crisis and a
potential downturn in the property market and it is widely believed that some
form of monetary easing may be in the pipeline so as to stimulate consumer and
business demand moving forward.

In UK news we
saw UK manufacturing output rises for the first time in 4 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 and 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.

Today will see
more rumour and intrigue around the Italian debt and political situations while
the Bank of England starts its 2-day meeting on interest rates.

Latest
exchange rates at time of writing