1. Watching the Formation of Italy’s New Government

Much of this week will be consumed with watching the formation of a new government in Italy. Following the passage of reform bills by both houses, Silve Berlusconi has stepped down as the Prime Minister and his party – the People of Liberty – has given their support to the incoming head Mario Monti.

However, that endorsement comes on the conditionality of how the cabinet will be structured as well as the timeframe for elections. In order for Monti to be able to pass through the reforms needed he needs broad cross party support, but it may be hard to imagine that the center-right and center-left parties in Italy would come together and work together. The Northern League said that it will go into opposition – they were the junior partner in the current government. Therefore let’s see how Monti is able to navigate the deep divisions and ideological differences within Italian politics as he tries to impose reforms that help bring back market confidence in Italy. The broader the support for Monti, the more comfortable market participants will be. How much hard adjustments are the people of Italy in for? We’ll know more as Monti gives us his prescription for what needs to be done to return Italy to a more sustainable debt path.

2. ECB’s Reluctance to be  Lender of Last Resort

One of the key ways to ease market concern over the current iteration of the euro zone crisis would be for the European Central Bank to decide to become a “lender of last resort” meaning that it would lend to governments that need in order to make sure they can meet their obligations. This is a role the ECB does not want, as it was set up with the sole mandate of price stability and its independence is supposed to be sacrosanct. It’s role is not supposed to be to bail out governments, rescue national banking sectors, and imposing austerity conditions on governments – that job is for politicians. Still, with national leaders’ actions so far not bearing fruit, and the European Financial Stability Facility still remaining under-leveraged to bring confidence the cry is going out for the ECB to step into that role.

The ECB could make an unlimited commitment to buy up Italy’s debt – which would lessen investors’ worries about Italy and others repaying their debt. Of course, printing money does not solve the longer-term problems that got Italy into its debt hole – it doesn’t help make it more competitive in terms of its wages and it doesn’t help break the power of vested business interests on much of Italy’s economy.

In the weekend edition of the Financial Times we had the Bundesbank president Jens Weidmann say that the ECB should not take on this role as lender of last resort. It would violate European law – especially the ban on ‘monetary financing.’ He also said that private sector involvement – the agreement that was constructed for Greece in the latest bailout talks can actually cause more contagion as it can be seen as a template and model for others debt-laden countries to follow.

3. US Retail Sales and other Macro Reports

While the focus remains on Europe, we do get several key US macro releases from the US to distract markets.

In the US we will get data on retail sales, producer and consumer prices, industrial production, housing starts, and the Philly Fed manufacturing index.

The main release is retail sales and a reading above expectations (0.3%) would help stocks and risk appetite.

The US economy is showing some signs of strengthening and if consumers continue spending that would be a positive as we move through the fourth quarter.

We also look to see if inflation continues to be contained – which would give the Fed more options if in fact we see economic conditions deteriorate. Monthly headline CPI is forecast to be flat in October, with core CPI up just 0.1%.

Industrial production is expected to rise 0.5% in October, following a 0.2% increase in September. The Philly Fed manufacturing index is forecast to rise to 9.3 in November, from 8.7 in October. That would show an improvement and would help boost stocks and risk appetite as well. A weaker number would do the opposite.

4. European 3rd Quarter GDP Expected to Show Improvement in Germany and France

In Europe, the key macro releases will be 3rd quarter GDP data from Germany, France, and the wider euro zone. In the second quarter GDP data disappointed and caused concern that the Euro-zone sovereign debt crisis had seeped into the real economy, short circuiting the single economy’s recovery.

French GDP is expected to show a 0.3% climb in the third quarter following flat growth in the second quarter, while the German economy is expected to grow 0.5% after a 0.1% increase in the second quarter. Therefore, we do see some improvement in the two largest economies in the euro-zone, but overall GDP is expected to remain at a weak 0.2% growth rate.

A positive surprise from the growth figures would help the EUR, but a disappointment will weigh on the single currency.

5. UK CPI, Quarterly Inflation Report, and Employment Data to Drive GBP

In the UK, macro data includes our latest look at consumer inflation, retail sales, and employment as well as the BOE Quarterly Inflation Report. The Inflation Report is likely to take a more pessimistic outlook for the economy and investors and traders will be looking for signs of more quantitative easing from the Bank of England, both in the report and in comments from Bank of England Governor Mervyn King.

Prior to the Inflation Report on Wednesday, the UK posts data on inflation for the October period in the first half of the week. The annual rate is expected to hover above the 5% level, coming in at 5.1% following a 5.2% reading in September. While the Bank of England has said repeatedly that inflation would go above the 5% annual rate and then decline, the longer inflation stays above 5%, the more it eats away at consumer confidence as well as real GDP growth.

In addition to inflation we have our latest report on employment. The October forecast for the claimant count is expected to show another 20.8K British workers claiming unemployment benefits. That would follow a 17.5K increase in September. The unemployment rate is expected to climb to 8.2% in September from 8.1% in August.

Therefore, we see the continued deterioration in the labor market which has been a major factor for the central bank in conducting its second round of quantitative easing announced in early September. Just to top it off we also have UK retail sales data where the forecast is for a 0.3% drop in sales in October following a 0.6% increase in September. Such a reading would show that UK consumers retrenched during the month, amid higher unemployment, stagnant wages, and high inflation.

This mix of reports should weigh on the GBP, unless we see them come in better than expected.

- Nick Nasad is the Chief Market Analyst at FXTimes – provider of Forex News, Analysis, Education, Videos, Charts, and other trading resources.

Information and opinions contained in this report are for educational purposes only and do not constitute an investment advice. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness. FXTimes will not accept liability for any loss of profit or damage which may arise directly, indirectly or consequently from use of or reliance on the trading set-ups or any accompanying chart analysis.