European markets drop to two-year low as fears mount over Italy budget

The euro has fallen against the pound and could tumble further if Italian risk escalates

The European Commission is expected to reject Italy's draft budget on Tuesday (Reuters)

European markets fell to a 22-month low on Tuesday, driven by fears over Italy’s budget, which is expected to be rejected by the EU.

Germany’s Dax, France’s Cac and Spain’s Ibex all fell in early trading, bringing the Euro Stoxx 600 index down 1.4 per cent to its lowest level since December 2016.

“We’re reaching peak stress in the Italian budget situation and that ugly tail risk carries a lot of headlines which in turn can drive flows,” said John Roe, head of multi-asset funds at Legal & General Investment Management.

“Italy’s dangerous game of chicken is weighing heavily on eurozone risk, as evidenced by the banks’ underperformance.”

The European Commission is due to give its opinion on the 2019 Italian draft budget on Tuesday, and is widely expected to reject it, after deeming Italy’s fiscal demands “unprecedented”.

Italy is aiming to lift its public deficit from 1.8 per cent to 2.4 per cent of GDP.

If the EU does ask Rome to revised its budget plan, the Italian government will have three weeks to come up with new ideas. A refusal to comply with the commission’s rules could cost Italy millions of euros in fines.

The euro tumbled against the pound on Tuesday, and could fall further if no agreement is reached between Italy and the EU.

“The prospect of a normalisation of monetary policy was the main reason why the euro was able to appreciate over the past year,” said Commerzbank analyst Thu Lan Nguyen. “However, there is a rising risk that this support is now going to crumble.”

Additional reporting by newswires