Euro. Picture: REUTERS/ALKIS KONSTANTINIDIS
Euro. Picture: REUTERS/ALKIS KONSTANTINIDIS

London — The euro bounced off six-week lows on Wednesday, European shares rose and Italian bonds rallied as some of the worries that have rippled across markets this week were soothed by signs Rome was amenable to cutting budget deficits and debt in coming years.

A report in the Corriere della Serra newspaper — later confirmed by a government source — said the deficit would fall to 2.2% of GDP in 2020 and to 2% in 2021 from the 2.4% earlier outlined.

That brought relief to markets that had fretted that Italy's decision to expand budget deficits well beyond what was agreed by a previous government would deepen its debt problems while stoking conflict with the EU, whose officials have already expressed concerns.

The euro, which had hit a six-week trough of $1.1506 after suffering five straight days of losses, firmed 0.3% while Italian borrowing costs eased off four-and-a-half-year highs, after jumping 50 basis points since budget details emerged last Thursday.

Two-year yields fell 15 basis points.

"It's all about Italy today. The news about a possible reduction in budget deficits has been positively taken by all markets, and the euro is back up too — that's the main risk parameter for euro crisis concerns," said Bernd Berg, global macro and forex strategist at Woodman Asset Management in Zurich.

A pan-European equity index opened 0.25% higher, while the Milan bourse jumped more than 1% . The moves were led by an initial 3.1% bounce in Italian banks. The banks' huge government debt holdings make them particularly vulnerable to bond sell-offs and has pressured Italian stock markets for months.

The moves pushed down the premium investors demand for holding Italian risk relative to that of safer Germany to about 290 basis points, down from a five-year high over 300 basis points on Tuesday and sapped some demand for safe-haven assets such as German bonds, the dollar and Swiss franc.

The euro jumped 0.5% to the franc and 0.4% to the yen. Analysts noted, however, that other southern European markets, Spain and Portugal, which were caught up in Greece's 2010-2011 crisis, had been resilient to spillover from Italy this year.

"Contagion has been far more subdued than in the past and that's an important signal. I expect policy makers to latch on to that as proof (Italy's crisis) is self-imposed and not a reflection of what's happening as a whole in the weaker [eurozone] countries," said Salman Ahmed, chief investment strategist at Lombard Odier in London.

He added that Italy's high yields — two-year bonds there pay 1.3% versus zero in Portugal — were also enticing some investors.

Wall Street too appeared set for a firmer open, with futures for the S&P 500 the Dow up about 0.2%.

Broader world market sentiment remains jittery though, partly because of the bellicose rhetoric still emerging from the coalition government in Rome, but also due to fears that a Sino-US tariff row would escalate once China reopens after a week-long holiday.

While US President Donald Trump agreed on a new trade pact with Mexico and Canada, a controversial clause in the trilateral agreement, forbidding similar deals with "non-market" countries, was seen as raising risks for Sino-U.S. talks.

Volatility in US tech shares is also making investors wary, with Facebook down almost 6% in the past three sessions after disclosing its worst security breach in its history.

World shares were flat near two-week lows while MSCI's index of Asia-Pacific shares outside Japan slipped 0.2% and Japan's Nikkei closed 0.7% lower.

China's financial markets are closed and will resume trading on October 8. That's the day Trump and Chinese President Xi Jinping are due to attend Group of 20 (G20) meetings, meaning news could emerge on the trade front.

The dollar index, measuring the greenback against a basket of major currencies, pulled back from six-week highs of 95.744.

Emerging currencies derived some relief from the weaker dollar but the Indian rupee hit a record low and the Indonesian rupiah touched a more than 20-year low, as oil prices near four-year highs weighed on importing nations' finances.

Indonesian authorities stepped in to support the currency and India is expected to raise interest rates on Friday.

Turkey's lira also weakened 1% to the dollar as the country, another oil importer, posted data showing inflation at more than 25%. That increases pressure on the central bank to raise rates again after a whopping 625 basis points move in August.

Woodman Asset Management's Berg said, however, that the worst looked to be over for Turkey, adding: "The currency has appreciated and the central bank has hiked rates aggressively so ... towards the end of the year, inflation numbers should stabilise and to me, the worst of the currency crisis is over."

Brent crude inched up to $84.89 per barrel, close to four-year highs of $85.45 touched earlier this week.

Reuters