Italian Bank Developments Impacting Euro: ECB Rate Effects and Windfall Tax Considerations

EUR: Italian banks take a breather

The ECB consumer expectations survey showed another decline in inflation expectations, with those for three years ahead easing from 2.5% to 2.3%, and those for one year ahead from 3.9% to 3.4% in June. This is a welcome indication for the ECB that its rate-hike cycle is having its effect, however: a) long-term inflation expectations remain above the 2.0% target, and b) market-based long-term inflation expectation measures have recently jumped.

On this second point, we suspect ECB officials were looking with concern at the 5Y5Y EUR inflation swap forward rate touching 13-year highs on Monday at 2.67%. It has now eased by around 5bp, but remains worryingly high compared to the mid-July 2.50% level, and potentially inconsistent with the end of a tightening cycle.

The eurozone calendar is quite light this week, but the euro felt some pressure yesterday as the Italian government announced a surprise windfall tax on bank profits, which hit sentiment in the European equity market. Some of the initial hit on bank stocks yesterday was due to a lack of clarity on the details of the new tax: this morning, it was confirmed that the levy won’t exceed 0.1% of each bank’s asset, which has been received as positive news by Italian bank stocks and helped the euro recover some ground.

The decision by the Italian government follows unanswered calls by commercial banks to raise deposit rates. This follows a similar move by Spain last year, and discussions in other major European economies. This is one interesting thread to monitor, should the Italian government's decision fuel a bank profit windfall tax debate in other countries, and/or whether banks will pre-empt facing new taxation by raising deposit rates. The implications can be non-negligible from a monetary policy transmission perspective and for the euro. In the near term, the relevance of relative equity performance for EUR/USD should keep it quite sensitive to the matter.

A return to 1.10 is possible today as global risk conditions improve and bank stocks appear to find some breathing room.