MORNING BID EUROPE-Italy: anti-establishment government beckons?

* A look at the day ahead from European Economics and Politics Editor Mark John and EMEA markets editor Mike Dolan. The views expressed are their own.

LONDON, May 10 (Reuters) - Italy's anti-establishment 5-Star Movement and the far-right League might be hours away from breaking a nine-week political deadlock if, as now expected, they sign a draft government deal today. Given that a 5-Star-League coalition would be likely to seek a renegotiation of EU budgetary discipline rules to allow Italy to spend more, this has already spooked bond markets, sending Italian yields higher. All this is a major turnaround from the situation of just a few days ago, when the stalemate looked to be sending the country inexorably towards new elections; the game-changer was the acceptance at last by Silvio Berlusconi that the League could enter a government without his Forza Italia party. That suggests the Berlusconi era of Italian politics is finally coming to an end this time.

With (Other OTC: WWTH - news) expectations by now firmly fixed that the Bank of England will hold back from an interest rate hike at today's meeting, investors want to see if Governor Mark Carney tries to keep market expectations of an August rate increase alive. Sterling fell to a four-month low against the U.S. dollar earlier this week as markets priced diverging prospects for growth and interest rates on the two sides of the Atlantic (Shanghai: 600558.SS - news) . Yet interestingly, economists polled by Reuters expect the UK currency to recover over the course of the year as markets bet that a "cliff-edge" Brexit without any trade deal is increasingly unlikely. That assumption comes just as a succession of defeats for the government over its Brexit bill in the House of Lords upper house has put the wind in the sails of anti-Brexit lawmakers. In particular, some assert a majority is now beginning to emerge in the more powerful lower house of parliament to back a Lords amendment that would keep Britain in the European Economic Area - effectively, something like a Norway-style "soft Brexit".

Today's award to France's Emmanuel Macron of the prestigious Charlemagne Prize for offering a "vision of a new Europe" has a slightly esoteric feel to it. For the person providing the laudation of Macron's "vision" at the ceremony in the German city of Aachen is none other than Angela Merkel - the very person who is blocking his ambitions for a more politically and economically integrated Europe. She (Munich: SOQ.MU - news) has largely poured cold water on Macron's ideas for reviving the EU, which include a stand-alone budget for the single currency bloc, a single finance minister, and other steps to reinforce economic and monetary union. That is prompting Macron to lower his ambitions for Europe, officials close to him say.

MARKETS AT 0655 GMT

Oil prices continue to be the main financial shock absorber surrounding the U.S. exit from the Iran nuclear deal, with the dollar taking something of a breather after its relentless climb over the past two weeks. Brent crude rose to another 3 1/2-year high of $77.89 overnight amid fears of some supply disruptions as the United States plans to re-impose sanctions on Iran later this year. Iraq’s oil minister said late on Wednesday that OPEC would this month discuss a possible shortfall of supplies related to the U.S. decision. The dollar, meantime, ebbed slightly from 2018 highs ahead of U.S. April inflation numbers out later on Thursday and as currency markets eye the Bank of England’s policy meeting and inflation report just before that. One of the driving forces of recent dollar strength has been the scaling back of expectations for interest rate rises outside the United States even as the Federal Reserve keeps tightening, and nowhere was that more obvious than the evaporation of UK rate rise speculation. Only two weeks ago, markets were almost fully priced for a quarter-point BoE (Shenzhen: 000725.SZ - news) rate rise today. Now (Frankfurt: 11N.F - news) they don’t see one before August at the earliest as UK economic numbers weaken. Sterling has lost over 5 percent against the dollar to a four-month low of $1.3482 over that period, but steadied back above $1.35 ahead of the meeting. Euro/dollar has firmed to $1.1870 from the 2018 low of $1.1821 set on Wednesday. Another example of the "last man standing" view of Fed tightening came from New Zealand earlier. The New Zealand dollar shed as much as 1.1 percent to a five-month low of $0.6916 after the Reserve Bank of New Zealand held interest rates steady and was much more dovish in its forward guidance and the direction of the next policy move.

The dollar’s pause has taken some pressure off emerging market currencies, which had been battered over the past week by the tightening of dollar funding conditions. Turkey’s lira has steadied after an emergency meeting of President Erdogan’s economic team on Wednesday, although there were few concrete conclusions from the gathering. Argentina’s peso remains under the cosh despite 40 percent interest rates and the country’s approach to the IMF for financial help. Malaysia’s election dominates emerging markets headlines this morning, however, with the country’s credit default swaps surging to five-year highs and pressure on the ringgit in the forward markets. Former Prime Minister Mahatir Mohamad’s possible return to power raises concerns among investors over the economic outlook, including his likely plans to scrap a goods and services tax, which would hit government revenues. Italian government bond yields jumped to a seven-week high on Thursday on an increased possibility that a government of anti-establishment parties will come into power in the euro zone's third-largest economy. Italy's anti-establishment 5-Star Movement and the far-right League are looking to end nine weeks of political deadlock following inconclusive elections and form a government. Stock markets remain buoyant during a buoyant earnings season around the world. The S&P500 was up almost 1 percent overnight, with most major Asian bourses following suit and European futures pointing higher too. The New Zealand dollar shed as much as 1.1 percent to a five-month low of $0.6916 after the Reserve Bank of New (KOSDAQ: 160550.KQ - news) Zealand held interest rates steady but was more dovish in its forward guidance.

* Europe corp events: Aegon (Swiss: AGN.SW - news) , Barratt Developments (Frankfurt: 859551 - news) (trading), Beazley (LSE: BEZ.L - news) , BT, CEZ, Coca-Cola (trading), Morrisons (sales), Next (EUREX: NXTJ.EX - news) (trading), Prysmian (EUREX: 3056144.EX - news) , Randgold Resources, RSA Insurance (LSE: RSA.L - news) (trading), TP ICAP (trading), Unione di Banche Italiane, Banco Mediolanum (Amsterdam: 976622.AS - news) , Acerinox (Madrid: ACX.MC - news) , Ferrovial (Amsterdam: FV6.AS - news) , Pekao (Editing by Larry King)