Just as in ancient times when power shifted from Athens to Rome, so too now the focus 0f the currency markets is inexorably moving from Greece to Italy.

Although the situation in Greece remains fluid as Prime Minister Papandreou struggles to form a temporary coalition government, the most immediate danger - the threat that Greece will not get the 6 billion euro bailout before it runs out of funds by early December - appears to have been averted.

With Mr. Papandreou backing away from his call to stage a national referendum on the issue of the EU bailouts, Greece will now have enough capital to muddle through for the next few months.

However, the credit crisis in Eurozone is far from over as markets now turn their attention to Italy. Investors have been increasingly concerned about the rise in Italian 10 years bonds which have traded above the 6 per cent level for the past several weeks.

Italy is the world's fourth largest issuer of debt and faces more than 300 billion in refinancing in 2012, which at current elevated interest rates could add nearly 11 billion euros in additional debt service costs for the country's treasury.

Some analysts have argued that given the fact that investors in EZ credit markets must now evaluate the individual credit risk of each member (since Germany and France refuse to provide a blanket guarantee) Italian BTP spreads to German bunds are consistent with the historical premium of around 450 basis points.

However, such analysis is cold comfort to Italian fiscal officials who must pay punitive interest rate service costs next year. More importantly, if the the gap remains at these levels for a considerable period of time LHC Clearnet may raise margins on Italian bonds creating further stress in the system. In the past such moves prompted both Ireland and Portugal to seek bailout funds as their sources of financing dried up.

The prospect of Italy being shut out of the credit markets is a far greater danger to the euro/dollar than all the prior periphery debt problems combined. Italy, the third largest economy in the euro block, is simply too big to rescue. That's why the interest rate on Italian bonds will be the key barometer of risk going forward and if BTP rates continue to climb the euro/dollar will see further selling pressure. 

Meanwhile, on the economic front, the data in the EZ continued to deteriorate with the final reading for the EZ PMI Services sector printing at 46.1 versus 49.1 the period prior. The news was dour all across the board with German data at 50.6 French data posting a very sharp drop to 44.6 and Italian PMI numbers sinking to 43.9. This was the worst reading in more than 2 years and suggests that EZ is headed straight into a recession which will only exacerbate the credit problems plaguing the region. 

This week the European economic calendar is relatively barren with only data of note coming out on Monday when EZ Retail sales and German Industrial Production reports are due.

If the numbers once again disappoint the downward pressure on the euro/dollar will increase markedly and the pair could tumble towards the 1.3500 level as shorts press their trades.

The writer is GFT Director of Research. Opinion expressed here is his own and do not reflect the views of Gulf News.