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Euro recovers from 3-week low

The euro tumbled to a three week low against the dollar on Thursday, but later recovered, after an EU official expressed confidence that Greece will receive its second financial aid package shortly.

The single currency fell to a three week low of $1.4072 before recovering to $1.4197 after European Union Economics Minister Ollie Rehn said he was confident that the International Monetary Fund and euro-zone governments will agree to pay Greece another round of aid in the short-term.

Meanwhile chaos continued in Greece as the country pushes through austerity measures in a bid to improve its debt crisis. As Prime Minister George Papandreou tries to reshuffle his cabinet an increasing number of party members are calling for him to stand down. Protests against austerity measures turned increasingly ugly on Thursday.

The dollar index, which measures the US currency against a basket of six currencies, slipped to 75.476 from a high of 76 earlier in the session.

The dollar traded at 80.58 yen from 80.95 yen the previous session.

Sterling fell to a three week low of $1.6078 as investors moved out of riskier assets. Disappointing UK retail sales also pressured the UK currency with an increasing number now expecting the Bank of England to keep interest rates ultra low for an extended period as recent lacklustre data indicates that the economy is struggling to recover.

Dollar

There will be further concerns over the US economic outlook after a run of generally weak releases and trends over the next few weeks will be extremely important for sentiment. The Federal Reserve will maintain interest rates at very low levels over the next few months and if there is evidence of renewed deterioration then there will be the possibility of additional quantitative measures. The US debt profile and political battle surrounding the debt ceiling will tend to undermine confidence in the near term while a deal would provide some limited relief. There is still scope for support from on defensive grounds, especially as underlying risk appetite is liable to be weaker.

The dollar found support on dips to beyond 1.44 against the Euro during the week and advanced strongly to highs near 1.4150. Increased Euro-zone fears were compounded by a sharp fall in commodity prices as the IEA announced that it would release strategic oil stocks into the market with risk appetite generally weak.

There were no surprises from the FOMC meeting with interest rates left on hold at 0.00 - 0.25% range. There was a downgrading of growth forecasts with the forecast expansion for 2011 cut to a 2.7 - 2.9% range from 3.1 - 3.3% previously. The Fed expressed some concerns over price increases, but it expected that inflation was expected to fall to or below the level consistent with full employment and inflation in the medium term. The Federal Reserve stated that interest rates would be held at low levels for an extended period and the inflation comments suggested that further quantitative easing could still be considered in the medium term.

Fed Chairman Bernanke declined to make any direct references to further quantitative easing and the main message was that there was a high degree of uncertainty over the situation. The dollar gained some support on relief that there was no mention of further quantitative easing at this time.

Jobless claims rose to 429,000 in the latest week from 420,000 previously while the new home sales data was slightly stronger than expected. There was no significant impact on interest rate expectations with markets still expecting the Fed to retain very low interest rates. There was a breakdown in congressional talks over raising the US debt ceiling and there will be a further lack of confidence in the US fundamentals.

Euro

The Euro-zone structural difficulties will remain an extremely important short-term focus as the Euro-zone and IMF maintain their efforts to prevent a debt default. Approval of austerity measures by the Greek government which would secure fresh support would boost immediate sentiment, although confidence is liable to subside again quickly given that default remains highly likely in the medium term. Failure to approve austerity measures would also trigger sharp initial Euro losses. Even though the Euro will gain some support on yield grounds, the net risk profile continues to suggest that the currency will depreciate in the medium term.

The Euro rallied at times, but was also subjected to heavy selling pressure, especially after ECB President Trichet warned over financing conditions within the Euro area. From a longer-term perspective there were further warnings over the Euro outlook, especially with little confidence that the Greek government will be able to deliver on austerity measures. There was further negative media rhetoric surrounding the underlying Euro outlook and Fitch warned that even a voluntary debt rollover would be considered a default.

The Greek parliamentary no-confidence vote was in line with expectations with the government winning by 155-143. Late in the week, the EU and IMF announced that they had reached agreement with the Greek government over a five-year austerity package. Approval of the package would secure a new EUR120bn rescue package for Greece which would prevent an immediate debt default.

There will now be another vote on austerity measures next week with approval critical if Greece is to secure the fresh Euro-zone backing and additional rescue package. The Euro rallied, but there was still a high degree of caution. The government will need to secure parliamentary approval for the measures on Tuesday and agreement is far from guaranteed, especially with the opposition party failing to back tax increases.

Even if a near-term agreement can be reached there will be fears that Greece will still default in the medium term. In the meantime, there will be fears over further underlying capital flight, especially with further weakness in the banking sector.

As far as the economic data is concerned, the German IFO index weakened to -9 for June from 3.1 previously and the PMI manufacturing index was at an 18-month low, maintaining expectations of a significant slowdown in the economy which would also make it even more difficult for peripheral economies to secure growth.

Sterling

Confidence in the economy will remain weak with further concerns over the outlook for consumer spending. Although inflation is continuing to run substantially above target, the Bank of England will not be in a position to raise interest rates significantly and real yields will remain very unattractive which will limit Sterling support. There will be doubts over the government’s fiscal policies. There will also be further unease over the banking sector, especially if there is the threat of losses from Europe. In this context, the UK currency will find it difficult to gain strong defensive support from difficulties within the Euro-zone and the net trend is liable to be for further depreciation against the dollar.

The headline government borrowing data for May was slightly better than expected at GBP15.2bn for the month from GBP7.7bn previously, although the underlying data, excluding financial interventions, was slightly higher compared with last year.

Bank of England MPC member Fisher stated his concerns over the growth outlook and also stated that further quantitative easing was possible if there was a sustained threat of deflation within the economy.

There was no surprise on the interest rate vote split in the Bank of England minutes with a 7-2 decision to hold rates at 0.50% at the June MPC meeting. The bank was generally gloomy over the economic outlook, warning that the weakness in demand was liable to last longer than expected. There were also references that several members considered the possibility of further quantitative easing if downside risks to the medium-term outlook materialised.

The minutes reinforced expectations that interest rates would remain at extremely low levels and there were also further fears surrounding the banking sector which sapped Sterling support. The UK currency weakened to 3-month lows below 1.60 against the dollar and also weakened to test support near 0.8950 against the Euro.

The Week Ahead

There will be immediate relief that there has been approval for the Greek austerity package and that a Greek debt default has been avoided. This will help underpin the Euro and boost risk appetite. The mood of confidence may not last long given important threats to the global economy, especially as there are still very important medium-term Euro-zone vulnerabilities.

Dollar

There has been some tentative evidence that the US manufacturing sector could be stabilising, but overall confidence in the growth outlook will remain fragile. There will also be strong expectations that the Federal Reserve will maintain interest rates at extremely low levels which will continue to curb dollar demand. The US debt-ceiling negotiations will remain an important focus and the dollar will remain be vulnerable if there is continued brinkmanship while any agreement would provide some relief. The global outlook will also remain important and immediate defensive US demand will be curbed by the Greek austerity package approval. Doubts over the global economic outlook should still provide some degree of protection for the US currency.

The dollar secured defensive demand early in the week, but his faded as Greek fears subsided and the currency was back on the defensive in the run-up to the end of the second quarter as the Euro moved to above 1.45.

The US jobless claims data recorded a slight decline to 428,000 in the latest week from 429,000 previously which did not have a major market impact. In contrast, the Chicago PMI index was significantly stronger than expected with a gain to 61.1 from 56.6 previously. This helped maintain a more positive attitude towards risk appetite with commodity currencies securing further near-term support.

The US consumer confidence data was weaker than expected with a decline to 58.5 for June from a revised 61.7 with the dip in energy costs not having any immediate positive impact on sentiment.

There was further unease surrounding the US debt ceiling as rating agencies continued to warn over the default risk which curbed dollar support.

Euro

There will be relief that the immediate threat of a Greek debt default has been averted following approval of the austerity package. There will also be strong expectations that the ECB will increase interest rates at the July meeting which will boost Euro yield support. There are still extremely important medium-term Euro-zone vulnerabilities given that the underlying debt and banking crisis is still liable to intensify and a Greek default is still unavoidable on a medium-term view. There is also scope for the ECB to take a more defensive attitude towards future interest rate hikes. The Euro will, therefore, find it difficult to extend gains from current levels.

EU officials continued to insist that there was no Plan B for Greece and that failure to approve the austerity package on Wednesday would block any further support for Greece and effectively trigger a debt default. The comments were also aimed at maximising pressure on the Greek government to bring potential rebels in line and secure the necessary majority. The Euro dipped to lows near 1.41 against the dollar.

Nearer the vote, there was greater market optimism over a yes vote which provided significant Euro support, especially when there was a wider improvement in international risk appetite. There were still important concerns surrounding the financial sector with reports that up to 15 Euro-zone banks could fail stress-test results

In this first vote, the austerity plan was approved by 155 votes to 138 with 1 PASOK MP rejecting the plan. There were further reports of sovereign Euro buying which continued to underpin the currency, especially with suggestions that China was buying aggressively and there was also evidence of month-end Euro buying.

As expected, the Greek parliament also approved detailed austerity package provisions and this was the final legislative barrier for the bills. There was relief that the package had been ratified and EU Finance Ministers should approve the next loan tranche for Greece this weekend. There will, therefore, be no near-term debt default for Greece which boosted the Euro and banks will also continue negotiations on terms surrounding a voluntary debt rollover.

ECB President Trichet re-iterated that the bank remained in strong vigilance mode, reinforcing expectations that there would be an interest rate increase at next week’s council meeting and the Euro gained further support on yield grounds.

Sterling

Confidence in the economy will remain weak with further concerns over the outlook for consumer spending, especially with credit availability still depressed. Given economic vulnerability and weakness within the banking sector, the Bank of England will not be in a position to raise interest rates significantly and real yields will remain very unattractive which will limit Sterling support. There will be doubts over the government’s fiscal policies and pressure for policy reversals will increase if there is further disappointing economic data. Any improvement in risk appetite could provide some degree of Sterling relief.

There were reports of further Bundesbank Euro/Sterling buying ahead of the month-end and there was also corporate Euro demand. This selling pushed the UK currency to a 15-month low on a trade-weighted index and beyond 0.90 against the Euro.

There was no revision to the first-quarter GDP data, in contrast to some hopes for an upward revision while the current account deficit narrowed to GBP9.4bn for the first quarter of 2011 from a revised GBP13.0bn previously.

In the Bank of England testimony on the inflation report and monetary policy there was a wide range of comments during the hearings and there will certainly be the threat that divisions will intensify over the next few months.

The underlying message was that interest rates would remain very low. MPC members were also keen to play down the possibility of any further quantitative easing with Governor King stating that further bond purchases could be seen as taking the easy option. The comments did help curb more aggressive Sterling selling.

The latest Bank of England credit-condition survey reported that consumer lending standards were set to tighten further during the third quarter which maintained fears over the consumer spending outlook, especially with lending levels already at historically low levels. There was also a renewed deterioration in consumer confidence according to the latest GfK index.

The Week Ahead

The Euro-zone will remain an extremely important focus over the next few weeks at least Although there will be periods of relief, the underlying stresses are liable to persist with the Euro still at high risk given the underlying debt structure. There will be further unease surrounding the global growth outlook with a particular focus on the Chinese prospects as debt and inflation uncertainties increase.

Dollar

There have been mixed US economic data over the past week with some relief over stronger than expected employment releases, although the payroll data will be pivotal for any durable rebound in confidence. There will still be expectations that the Federal Reserve will maintain interest rates at extremely low levels. The US debt-ceiling talks will be monitored closely as further speculation over a debt default would put the US currency under strong selling pressure. International considerations will remain extremely important and there will be defensive dollar support from fears over the Euro-zone and from unease over a slowdown in the global economy. Overall, there is scope for limited dollar gains.

The dollar gained support at times from stresses within the Euro-zone, especially when risk appetite also deteriorated, but it found it difficult to sustain gains as underlying confidence in the currency was still weak and the trade-weighted index only made limited headway.

The ISM index for the services sector was weaker than expected with a decline to 53.3 for June from 54.6 the previous month, reinforcing expectations of slow growth within the economy. There was a sharp deterioration in orders and prices for the month while the employment index held steady. Overall, the report reinforced expectations of subdued growth.

The US labour-market data was stronger than expected with an increase in ADP private-sector employment of 157,000 for June from a revised 38,000 previously while there was also a decline in jobless claims to 418,000 from 432,000. The data triggered some optimism over Friday’s pivotal US employment release and there was also speculation over a near-term agreement on raising the debt ceiling following protracted negotiations during the week. There were no major comments on monetary policy during the week.

Euro

The Euro-zone debt crisis will continue to be watched very closely in the short-term, especially given the contagion risks surrounding peripheral economies as the authorities have been unable to contain the rise in yields. There is also still a high risk of a Greek debt default in the medium term while the banking sector will remain vulnerable. There will be initial yield support for the Euro following the ECB increase and relatively hawkish method, but support may be transitory given fears that there will be additional downward pressure on the weaker economies. It will still be difficult for the Euro to gain sustained support given the structural vulnerabilities.

The Euro was capped around 1.4550 against the dollar and came under further selling pressure during Wednesday as Euro-zone sovereign-debt fears increased again following Portugal’s rating downgrade by Moody’s. There was a further widening of yield spreads with Portugal’s benchmark 10-year benchmark yields rising to over 10% above German bonds as there was forced selling from institutions.

Following talks surrounding the Greek private-sector debt roll-over plans, IIF head Dallara stated that any solution to Greece’s problems could involve a temporary default and there was also evidence that roll-over participation would be limited as many institutions had already sold their bonds. More positively, Moody’s stated that it would differentiate between peripheral countries which could spare Ireland from immediate action. There were still fears of a widening contagion effect with rumours that Italy could be downgraded and unease surrounding the Spanish banking sector.

There was no surprise with the ECB interest rate decision with a 0.25% increase in the benchmark repo rate to 1.50% and the deposit rate was also increased. In the press conference following the decision, President Trichet stated that policy was still accommodative and that there were upside risks to inflation. These comments were very similar to those seen following the April interest ate increase and suggested that the central bank was expecting to increase rates again later this year.

In response, the Euro advanced strongly to the 1.4370 area with a covering of short positions taken in anticipation of a more dovish Euro tone. The ECB also announced that it would abandon collateral requirements for Portuguese banks looking to borrow from the ECB. Such a more was necessary following the downgrade of Portugal’s credit rating to junk status and will prevent an immediate liquidity crisis.

The German constitutional court also started its hearings into the legality of German contributions to a Greek rescue fund on Tuesday which will add to the mood of uncertainty. The Euro-zone economic data provided some degree of relief with a rise in the Sentix index for the month, although this was over-shadowed by underlying fears surrounding the sovereign-debt outlook and European financial sector.

Sterling

Confidence in the economy will remain weak with further concerns over the outlook for consumer spending. The Bank of England has again held interest rates on hold at 0.50% and expectations of a loose monetary policy over the next few months will continue to undermine Sterling yield support. Any further escalation in strike activity would also undermine confidence in the outlook and spark speculation over a shift in government policies. Sterling will also tend to lose support if there is any deterioration in risk appetite, especially as UK bank-sector vulnerability would become a greater focus.

Sterling remained generally vulnerable during the week and tested support beyond 0.90 against the Euro before a partial recovery while there was also a retreat to below 1.60 against the dollar.

The PMI services-sector index edged higher to 53.9 for June from 53.8 previously. Although only slightly stronger than expected, the data did help stem near-term pessimism towards the economy and there was a covering of short positions.

There was also a 0.9% rebound in UK industrial production for May following the sharp decline previously and the manufacturing data was stronger than expected which provided relief. Less positively, the NIESR estimated that GDP growth slowed sharply in the three months to June to 0.1% from 0.5% previously which maintained concerns over a weak economy.

As expected, the Bank of England left interest rates on hold at 0.50% following the latest MPC meeting. There was no statement with the decision and the vote breakdown will not be known for two weeks. Markets overall will be expecting very low interest rates to continue over the next few months which will also continue to leave Sterling vulnerable on yield grounds, especially after the ECB rate hike.

The Week Ahead

Immediate confidence in the Euro-zone and US economies will remain very weak. The Euro still looks to be at higher risk over the next few weeks as a whole given the underlying debt structure and major barriers to a convincing solution. There will be further unease surrounding the global growth outlook with a particular focus on the Chinese prospects as debt and inflation uncertainties increase with international risk appetite likely to be extremely fragile.

Dollar

Confidence in the economy will remain fragile in the short-term with fresh concerns over the outlook for consumer spending, especially after the much weaker than expected employment report released at the end of last week. The Federal Reserve will not take any additional policy action at this time, but interest rates will certainly remain at very low levels and there will be speculation over additional quantitative easing later in 2011. The debt-ceiling negotiations will be watched very closely in the short-term and without a quick resolution, confidence is liable to deteriorate quickly. The US currency can still gain some net support on defensive grounds, particularly with the Euro-zone extremely vulnerable, but the dollar will find it difficult to advance very far.

The dollar was initially undermined by the much weaker than expected US employment data at the end of last week before strengthening rapidly as Euro fears intensified. The dollar retreated again, but did secure a net advance for the week against the Euro in choppy trading conditions.

The headline US retail sales data was close to expectations with a 0.1% monthly increase while underlying sales were unchanged. Jobless claims fell to 405,000 in the latest week from 427,000 previously. The trade deficit rose to a 30-month high of US$50.2bn from a revised US$43.5bn previously as oil imports rose strongly and there will be a negative impact on US GDP estimates.

The FOMC minutes from June’s meeting reported that there was a high degree of uncertainty over growth and inflation prospects. Exit strategies were discussed in length, but FOMC members also admitted that plans might need to be changed.

In testimony to the US House of Representatives on the semi-annual monetary report, Fed Chairman Bernanke remained generally downbeat over the economy with warnings that the period of economic weakness was lasting longer than expected. Bernanke also stated that the Fed would consider providing more monetary stimulus if the economy deteriorates further. The comments reinforced speculation that there could be further quantitative easing which also put the dollar firmly on the defensive.

Dollar sentiment was undermined further by Moody’s announcement that it was putting the AAA credit rating under review for a possible downgrade due to the potential default risk associated with failure to raise the debt ceiling. The impact was magnified by the lack of progress in the debt-ceiling negotiations ahead of the August 2nd deadline and Standard & Poor’s also put the US credit rating on negative watch.

In the second part of congressional testimony, Fed Chairman Bernanke stated that inflation was higher than in 2010 and that the Fed was not prepared for further action at this time. These remarks lessened immediate speculation over any additional quantitative easing and the dollar recovered ground.

Euro

The Euro-zone debt crisis will continue to be watched very closely in the short-term, especially as the contagion risks surrounding peripheral economies remain much higher. Although the immediate sense of panic has eased, yields have risen sharply and sentiment has continued to deteriorate. There will need to be a much more decisive stance on the Greek and wider peripheral situation to boost market sentiment and there will be increased expectations that the Euro will break up. In this context, the Euro will find it difficult to gain sustained support from higher interest rates and volatility is liable to remain high.

The Euro came under further heavy selling pressure on Tuesday, retreating to the weakest level since early March below 1.3850 as the Euro-zone debt crisis intensified. There was a fresh surge in peripheral bond yields as Italian benchmark yields briefly increased to above the 6.0% level as panic selling increased. There were also reports that regional Spanish budget deficits were much worse than officially stated which served to further undermine confidence.

There were reports that the ECB was buying EU bonds and there were also reports of strong Chinese interest which helped stabilise confidence with Italian yields returning to below 5.70%. In tandem, the Euro recovered quickly against the dollar.

There was also relief that Italy managed a relatively successful bond auction, but yields still rose substantially from the previous auction, illustrating how much sentiment has shifted and there were still very important fears surrounding the Italian contagion risk with persistent concerns over Spain as well. Austerity measures were approved in the Senate and will now face a Lower-House vote on Friday.

The bank stresses-test results will also be announced on Friday with markets uneasy over the outcome and the methodology used. There was further uncertainty surrounding an emergency EU Summit with Germany still resisting plans and the underlying mood of uncertainty remained an important negative Euro influence.

Sterling

Confidence in the economy will remain weak with further concerns over the outlook for consumer spending and the possibility of a wider downturn in growth. Expectations of a loose monetary policy will continue to undermine Sterling yield support. Euro-zone developments will be watched very closely and, although Sterling could gain defensive support initially, sentiment could turn rapidly if contagion spreads to UK debt markets, especially as UK bank-sector vulnerability would become a greater focus. Sterling is unlikely to make much headway given the yield and risk structure.

The UK consumer inflation data for June was also weaker than expected as the headline rate fell to 4.2% from 4.5% while the core rate retreated to below 3.0%. The decline eased immediate pressure for the Bank of England to raise interest rates which will maintain a lack of Sterling yield support.

The trade deficit was also wider than expected at GBP8.5bn for May from a revised 7.6bn previously. The data will increase doubts over the UK ability to secure growth through exports and will trigger a downgrading of growth prospects. The unemployment claimant count increased by 24,500 for June, the largest increase for over two years. Although there were distortions there will be fears that the rise will increase strains on the budget position as welfare commitments increase.

Sterling found support below 1.58 against the dollar and rallied firmly over the second half of the week as the dollar weakened and Sterling was able to hold its ground.

The Office of Budget Responsibility (OBR) warned that the fiscal position was unsustainable and that further policy tightening would be required over the next few years. The Euro-zone debt crisis and implications for the UK economy also remained under close scrutiny. Markets at this stage are still seeing some defensive qualities for Sterling as there has been no negative impact on UK bond yields. Sentiment could still reverse rapidly over the next few weeks.

The Week Ahead

Immediate confidence in the Euro will be strengthened by the fresh support package for Greece. There are still very important political barriers that will need to be overcome and the tensions will tend to increase again if there is evidence of a further downturn in the Euro-zone economy. In this context, any market respite could still prove to be short-lived.

Dollar

Negotiations surrounding the US debt ceiling will continue to be watched very closely as the August 2nd deadline draws closer. The dollar is likely to be subjected to heavy selling pressure if there is no deal while there will be some relief if default is averted. Underlying confidence in the economy will remain weak following a series of lacklustre economic reports. The Federal Reserve will keep interest rats at extremely low levels and there will be some further speculation over additional quantitative easing. Immediate defensive demand for the dollar will tend to be lower, but concerns over the global economy are liable to increase again which will provide protection. The dollar remains substantially under-valued from a longer-term perspective.

The dollar gained support early in the week as the Euro was subjected to heavy selling pressure and there was a deterioration in risk appetite, but the US currency lost ground heavily over the second half of the week with the trade-weighted index threatening lows seen in May.

The US housing data was weaker than expected with existing home sales falling to an annual rate of 4.77mn from a revised 4.81mn previously as cancellations also increased, dampening optimism triggered by firm housing stats data on Tuesday.
The Philadelphia Fed index rose to 3.2 for June from -7.7 previously while jobless claims rose to 418,000 from 408,000 previously.

The latest US capital account data recorded a decline in net long-term inflows to US$23.6bn for May from US$30.6bn the previous month which suggested that foreign appetite for US investments had fallen, although there was an increase in long-term US Treasuries held by China.

There were further negotiations surrounding the US debt ceiling, but rumours of a deal were denied by congressional leaders as the deadline moved closer. There were no substantive comments from Federal Reserve FOMC members during the week.

Euro

The second rescue package put together for Greece will ease immediate market fears over disorderly contagion within the Euro area which will also reduce market fears over the currency. There will still be doubts over the effectiveness of the plan in the medium term, especially as Greece will still be trapped win recession. There will also be increased concerns over the economic outlook following a further deterioration in the latest PMI releases. The Euro will continue to benefit from yield support if market fears can be calmed, but the currency still faces strong barriers to sustained gains, especially given the risk of political opposition.

The Euro remained firmly on the defensive in European trading on Monday as Euro-zone debt fears continued to increase. There was a sharp move higher in peripheral yields with Spanish yields above 6.3% while Italian yields again pushed above 6.0% with yield spreads over German bunds at their highest since the Euro’s inception in 1999 as the bank stress tests announced on Friday failed to bolster confidence.

The flash Euro-zone PMI manufacturing index fell to 50.4 for July from 52.0 previously which was the lowest reading for 23 months while the services-sector index also dipped sharply to 51.4 from 53.7 previously. There were increased fears surrounding the economy which would also increase pressure on weaker members.

Following an extended meeting between German Chancellor Merkel and French President Sarkozy, there was an announcement that they had reached a joint negotiating position ahead of Thursday’s meeting.

As EU leaders prepared for the emergency Summit, reports that the Greece could be put into selective default undermined confidence and pushed the Euro lower. The currency swiftly reversed losses with strong gains from the New York open as markets grew more confident over the outcome and there were suggestions that the ECB would not block any deal.

The EU leaders agreed a EUR109bn support package for Greece. The ESFS fund will be expanded and have a bigger future role as it would be able to buy secondary bonds if necessary to prevent contagion. Interest rates on ESFS bonds will also be lowered to 3.5% which ease the loan-repayment burden on weaker economies. There will be debt write-downs of around 20% on private-sector bondholders while the ECB indicated that it would continued to accept Greek bonds as collateral even if Greece is declared in temporary default. The Euro gained relief on an easing of immediate contagion fears, although the political implications will also be watched very closely given the potential for substantial opposition within Germany.

Sterling

Confidence in the economy will remain weak with further concerns over the growth outlook, especially with fears over a weak second-quarter GDP release. Expectations of a loose monetary policy will continue to undermine Sterling yield support even if the Bank of England resists further quantitative easing. Underlying confidence in the government’s economic policies is also liable to falter which will curb currency support. Sterling is unlikely to make much headway given the yield and risk structure, although immediate fears surrounding the banks should ease.

Sterling weakened ahead of the Bank of England minutes on Wednesday with lows near 1.6070 against the US dollar. The MPC vote from July’s meeting was in line with expectations at 7-2 with Weale and Dale again voting for an increase in rates. There was a further warning that inflation was liable to rise to above the 5.0% level and there was no suggestion of additional quantitative easing in the short-term.

Although the minutes did state that the possibility of a near-term increase in interest rates had receded, markets were relieved over the absence of quantitative talk and Sterling rallied. The retail sales data was slightly stronger than expected with a 0.6% monthly increase for June following a revised 1.3% decline the previous month as non-food sales recovered, but there was still little increase for the second quarter.

The latest government borrowing requirement of GBP12.0bn pushed the deficit for the first quarter of the fiscal year to GBP39.2bn from GBP39.5bn last year. Uncertainty over the economic environment will continue and there will be expectations of a weak second-quarter GDP reading next week.

The Week Ahead

The US debt-ceiling situation will be watched very closely in the short-term and any outcome which resulted in default would cause very serious market stresses. Ironically, the US dollar could actually gain support as underlying risk appetite would deteriorate sharply, and there would be increased fears surrounding the European banking sector. Some form of compromise deal remains the more likely outcome which would maintain speculation over a US credit-rating downgrade. Volatility levels are liable to remain elevated, especially with doubts over the global economy.

Dollar

Negotiations surrounding the US debt ceiling will continue to be watched very closely as congressional leaders battle to meet the August 2nd deadline, although the Treasury would be able avoid default for a further period. Failure to reach agreement would severely damage dollar sentiment, although it could gain defensive support if global risk aversion deteriorated sharply. There will still be underlying fears over a credit-rating downgrade even if default is avoided. The economy is likely to remain subdued in the short-term and the Federal Reserve will keep an accommodative monetary policy which will limit US yield support. Heavy selling should be avoided given the dollar remains substantially under-valued from a longer-term perspective.

The dollar secured net gains against the Euro with a move to near 1.4250 and did manage to stabilise on a trade-weighted index, but it was still searching for sustained buying support as US economic and debt-rating fears increased.

The US economic data was stronger than expected with jobless claims falling to 398,000 in the latest week from 422,000 previously while there was a 2.4% increase in pending home sales. The US Beige Book reported that activity had slowed in some districts during the past few weeks and there was also a weaker than expected durable goods report with a 2.1% decline for June.

The data impact was over-shadowed by congressional inability to secure any agreement over the budget and debt ceiling. Markets continued to fret over the possibility of a debt default, although Treasury sources indicated that there would be some room for manoeuvre after the August 2nd deadline. It is also the case that markets, at this stage, are more worried over the threat of sovereign-rating downgrade by at least one of the major agencies. There is certainly a high risk that underlying damage caused by the default impasse will trigger a ratings downgrade.

After tortuous hours of negotiations between Republican members, the scheduled House of Representatives vote on its debt-ceiling bill was postponed and then finally cancelled as the leadership did not have the votes to pass the legislation. Market anxiety inevitably increased sharply following the vote cancellation as there would be no real possibility of any agreement being reached ahead of the weekend, especially as the Senate has already pledged to reject the House bill.

There will be increased fears that the US could default and contingency planning will be watched very closely during Friday. The net impact was to weaken the dollar, although clear direction was lacking as players looked for defensive plays.

Euro

The Euro has struggled to maintain the support seen following the Greece rescue package with markets still uneasy over the contagion risk. Given that legislation will be required to secure additional funding for the EFSF, markets will be concerned that there will still be a lack of effective response if other peripheral economies come under attack and there will be further concerns surrounding Italy and Spain. The ECB will also come under heavy criticism if there is evidence of further economic deterioration. In this context, the Euro will find it difficult to take advantage of US vulnerability.

Last week’s EU summit agreement to provide an additional EUR109bn support package to Greece did initially support the Euro, but it was unable to sustain the gains as underlying doubts persisted.

German Finance Minister Schauble warned that there was no blank cheque related to EFSF funds which ensured further political doubts over the Greek rescue deal, although he also stated that there should be no un-controlled exits from the Euro area.

There were renewed tensions surrounding Euro-zone peripheral bond markets with Italian and Spanish yields rising sharply. Weak demand pushed Italian yields to an 11-year high which increased the fear of contagion and had a negative impact on the Euro. There was also further evidence of stress within the banking sector.

Moody’s put Spain’s credit rating on review for a possible downgrade and downgraded regional ratings which reinforced the potential contagion risk and there were further concerns over the Euro-zone banking sector.

Sterling

Confidence in the economy will remain weak with further concerns over the growth outlook. Expectations of a loose monetary policy will continue to undermine Sterling yield support and underlying confidence in the government’s economic policies is also liable to falter if business confidence deteriorates further. There will be some further short-term protection and possible safe-haven demand from fears over the US and Euro-zone outlook, but Sterling will find it difficult to gain more than limited support given the weak underlying fundamentals and fears over a renewed downturn.

Sterling proved broadly resilient during the week with little net change against the dollar while it did advance against the Euro with Sterling being seen ironically as a potential safe-haven despite fears over the economy.

There was relief over a 0.2% quarterly increase which was in line with market expectations, especially given fears that there could have been a contraction. There were distortions caused by the Royal wedding and bank holidays with the ONS estimating that there could have been an underlying 0.7% increase for the quarter.

The latest consumer confidence index recorded a further decline to -30 for July from -26 previously which was a fresh two-year low and maintained fears over the economic outlook, especially with downbeat CBI surveys on manufacturing and consumer spending as sales expectations declined to a 12-month low. The Nationwide did report a 0.2% monthly increase in house prices for July.

Bank of England MPC members Miles and Weale both warned that the economy could retreat back into recession, although this was not his expected outcome. He also stated that inflation was a real concern, illustrating the serious difficulties faced by the Bank of England in setting policy.

International considerations remained extremely important and, despite unease over the economic outlook, Sterling did appear to be receiving some defensive support as risk appetite deteriorated. There was a decline in UK benchmark bond yields as US confidence deteriorated.

The Week Ahead

Fear is likely to be the dominant short-term influence. There will be sharply increased concerns over the global economy and there will also be further fear surrounding the Euro-zone as the contagion effect threatens to spread to core economies. There will be pressure for much more decisive action by European governments and there will also be speculation over additional quantitative easing by the Federal Reserve with high volatility.

Dollar

Although there will still be fears over a credit-rating downgrade, there will be relief that the US debt-default risk has been removed and this will allow the dollar to gain defensive capital inflows when risk appetite deteriorates and liquidity dips. There will be concerns over the economic outlook following a run of generally disappointing data and there will be further speculation that the Federal Reserve will consider further quantitative easing in order to support the economy, especially if there is another weak employment report. In this environment, underlying confidence in the dollar will still be limited and it will remain dependent on weakness elsewhere to make strong headway.

The dollar secured strong net gains for the week with rapid appreciation against commodity currencies as growth fears increased. There was a rise in Libor rates and fears over a banking crisis in Italy which triggered further defensive demand for the dollar. The Euro also fell sharply, but did find support below 1.41.

After a weekend breakthrough on the US debt talks, the House of Representatives did pass the compromise budget deal which sanctions an increased debt ceiling. The US Senate comfortably approved the US debt-ceiling legislation and Obama’s signing of the bill formally removed any default threat. Moody’s affirmed its AAA credit rating for the US while Fitch stated that the situation was still under review.

The US ISM index for the manufacturing index was sharply weaker than expected with a decline to 50.9 for July from 55.3 the previous month and the lowest since June 2009. The much weaker than expected data undermined confidence in the US economy and also had an important impact in damaging risk appetite.

The ISM index for the services sector dipped to 52.7 for July from 53.3 the previous month, maintaining concerns over the economy. As far as the components were concerned, there was a weak reading for orders and the employment index.

The US jobless claims data was slightly better than expected with a dip to 398,000 in the latest week, but the impact was overshadowed by a sharp decline in equity markets as fear over the economy increased. There was fresh speculation over a fresh Federal Reserve move to expand quantitative easing given the run of disappointing data and the Friday employment report will be watched very closely.

Euro

Underlying confidence surrounding the Euro-zone economy will remain weak in the short-term with further fears over the contagion risk as investors flee the more vulnerable economies. The implications of severe stresses within Italy and Spain will be particularly damaging as EU governments do not have the funding available to provide an effective support mechanism for these countries. If the contagion threat cannot be eased, there will be further speculation over a break-up of the Euro area. There will still be Euro support from strength in Germany and speculation over the eventual emergence of a new ‘hard-Euro’ zone. Nevertheless, the currency is likely to remain vulnerable in the short-term.

There was a further increase in Euro-zone tensions during the week with a sharp widening in peripheral yield spreads. Italian yields rose to 14-year highs while Spanish yields also rose sharply. Italian officials held emergency meetings on Wednesday while Spanish Prime Minister Zapatero also stated that holiday plans would be postponed to monitor the economic situation.

There was further speculation that an expansion of the EFSF would be required, but this would run into heavy political opposition and markets doubted the commitment for a near-term increase, especially from Germany.

There was no surprise in the ECB interest rate decision with rates left at 1.50%. At the press conference following the meeting, there was still some tough talk on inflation from President Trichet, but he also stated that the growth outlook had deteriorated.

The ECB announced the provision of unlimited liquidity through six-month financing operations and also announced the resumption of peripheral bond buying. The ECB buying was confined to Ireland and Portugal with no action in the crucial Spanish and Italian bond markets. This division caused major doubts over the ECB commitment which undermined market confidence. The German Bundesbank opposed the decision and sources indicated that there were other votes against the move.

In this environment, sentiment deteriorated and there was a fresh widening in peripheral spreads which triggered sharp Euro losses. There were negative comments from EU commission head Barroso and Italian Finance Minister Tremonti which criticised the official response to the Euro-zone crisis.

Sterling

There will be further concerns over the growth outlook, especially as weaker global growth will make it even more difficult for the UK to boost exports. There will be relief over the recent services-sector data which should prevent any immediate move towards further quantitative easing, but there will still be expectations of extremely low interest rates which will limit support. The currency will also tend to weaken when risk appetite deteriorates, limiting the protection from weakness in the Euro area. Any Sterling selling pressure could be intense if there are renewed stresses within the banking sector.

Sterling was blocked above 1.64 against the dollar during the week and weakened to lows near 1.6220 as Euro losses triggered a US advance against Sterling. The UK currency did secure net gains against the Euro with a two-month high near 0.8650.

The UK PMI manufacturing index was sharply weaker than expected with a decline to 49.1 for July from a revised 51.4 previously and this was the lowest level for over two years. In contrast, the services-sector report was stronger than expected with an increase to 55.4 for July from 53.9 the previous month which was the highest reading since March and helped ease immediate fears over the economy.

Given the high degree of stresses within global markets and fears surrounding the Euro-zone, the Bank of England interest rate decision went almost un-noticed.
The MPC left interest rates unchanged at 0.50% while the amount of quantitative easing was also left on hold at GBP200bn with no statement.

The financial sector will remain under close scrutiny in the short-term as banking-sector shares continue to fall sharply. If there is any further widening in interbank spreads, then the net cost of borrowing will increase which will further damage the economy and could force additional Bank of England quantitative easing.

The Week Ahead

Fear is likely to remain the dominant short-term market influence. There will be further concerns surrounding the global economy and there will also be further fear over the Euro-zone as pressures increase within the financial sector. Markets will find it difficult to find defensive plays, especially with resistance to currency gains by the Swiss National Bank.

Dollar

There will be further concerns over the economic outlook as confidence remains extremely fragile with sentiment undermined by weak manufacturing surveys. Low interest rates will help support spending and construction, but there will still be additional speculation that the Federal Reserve will ultimately move towards additional quantitative easing. The dollar will, therefore, remain vulnerable on fundamentals grounds, but there will be defensive support as fears surrounding the global outlook increase. The dollar will also gain support if funding pressures increase and there should be a solid near-term tone.

There was little confidence in the US economy during the week, but the US currency did gain renewed defensive support as risk appetite deteriorated again with the Euro weakening to lows below 1.43 from a peak just above 1.45.

The US jobless claims data was slightly higher than expected at 408,000 in the latest reporting week, but the main surprise was in the Philadelphia Fed survey. The index declined sharply to -30.7 for August from 3.2 previously with all the main components deteriorating and this was the lowest reading since 2009. With existing home sales also weaker, the data reinforced market fears over the economy even though regional indices can give a misleading impression of national trends.

Headline consumer prices rose 0.5% for July which was also significantly higher than expected to give a 3.6% annual increase and there was a core reading of 0.2%. The combination of weaker growth and higher headline inflation will create significant discomfort within the Federal Reserve and comments from key officials will remain under close scrutiny in the short-term.

There was further unease surrounding the European banking sector, especially with further reports that some banks were having problems in securing necessary liquidity. There was a further increase in Libor rates and there will be some dollar support on structural grounds, although central bank liquidity provisions should prevent major difficulties. US 10-year Treasury note yields also dipped to record lows below 2%, a clear indication of defensive demand. Ratings agency Fitch affirmed its AAA rating for the US and a stable outlook, in sharp contrast to the Standard & Poor’s analysis.

There was criticism of the Federal Reserve’s policies from regional Presidents Plosser and Fisher who stated that it was not the Fed’s role to protect stock-market investors.

Euro

Underlying confidence surrounding the Euro-zone economy will remain weak. There will be further concerns surrounding the sovereign-debt issues and the debt problems will intensify if there is a further downturn in economic activity. The ECB will be forced to maintain peripheral bond buying in the short-term and will also be under pressure to reverse recent interest rate increases. There will be further demands for faster political progress to alleviate pressure on the ECB, but there will be strong resistance to further support, especially within Germany. High volatility is likely to remain the key market factor.

The Euro proved resilient during the week, but retreated over the second half as risk appetite deteriorated and structural fears increased. The Euro-zone GDP data was weaker than expected with German second-quarter growth of 0.1% compared with expectations of a 0.5% gain and this helped drag Euro-zone GDP expansion to 0.2% from 0.8% previously.

There was further market speculation over the issuance of Eurobonds ahead of the meeting between German Chancellor Merkel and French President Sarkozy. In the event, the meeting rejected the issuance of bonds at this stage with a concentration on measures to strengthen governance such as tighter rules on budget deficits. There was also further strong political opposition to Eurobonds from the German coalition FDP partners and there is also substantial opposition within Merkel’s CDU party as well as countries such as Finland and the Netherlands.

The headline Euro-zone inflation rate was confirmed at 2.5%, but there was a significantly weaker than expected reading for the core rate which fell to 1.2%. Diminishing inflation and weaker growth will maintain pressure for the ECB to switch to an easier monetary policy.

The ECB announced it bought EUR22bn in peripheral bonds over the previous week.
The bank also continued to discourage short selling in peripheral bonds by its presence either as a buyer or potential buyer. There was also evidence of tensions in the banking sector as a bank tapped the ECB 7-day emergency liquidity facility for the first time since February.

There were reports that Finland was looking for additional collateral on loans to Greece. As equity markets came under heavy selling pressure, the Euro fell sharply to lows around 1.4270 before correcting higher. There was a further suspicion of sovereign Euro buying at lower levels which protected the currency.

Sterling

There will be further concerns over the growth outlook with little prospect of relief within the domestic economy and the global outlook has also deteriorated further. The Bank of England will not increase interest rates in the short-term and there will be further speculation over additional quantitative easing if there is any further deterioration in business confidence. Sterling can gain some defensive support from being outside the Euro-zone, but this backing could prove to be extremely fragile given fears over the banking sector and yields support will remain extremely weak.

Sterling maintained a firm tone during the week with a 14-week high against the dollar and it also strengthened against the Euro.

Headline consumer inflation rose to 4.4% for July from 4.2% while the core rate rose to 3.1% from 2.8%. With inflation again outside the 1-3% range, Bank of England Governor King was forced to write a letter of explanation to the Chancellor. King remained concerned over the inflation outlook, but was more worried over the potentially severe risks posed to the economy by the Euro-zone crisis.

The latest employment data was weaker than expected as the unemployment claimant count rose 37,100 for July, the largest increase for two years after a revised 31,300 increase the previous month as unemployment rose to 7.9% from 7.7%. Retail sales rose 0.2% for July. Real yields remained highly negative as the 10-year benchmark gilt yield fell to below 2.45% with Sterling gaining some defensive support from its position outside the Euro-zone.

The Bank of England minutes recorded a 9-0 vote for unchanged interest rates at the August meeting as Weale and Dale dropped their preference for higher interest rates and this was the first unanimous vote on interest rates since May 2010. There were further concerns over the economy, but the majority of members did not consider that it was appropriate to expand quantitative easing at this time.

The Week Ahead

The financial sector will be an important focus in the short-term with further speculation that liquidity and solvency will deteriorate further which could cause severe stresses within Europe. If doubts over the Euro’s future also intensify again, there could be substantial defensive capital flows into the US dollar with volatility set to increase again.

Dollar

There will be expectations of persistently weak growth in the short-term with fears that the economy is close to recession. The Federal Reserve will look at options to support the economy and, even if further quantitative is resisted in the near term, yield support will continue to be very weak. There will be further fears surrounding the global economy and there will also be a lack of confidence in the European banking sector. In this environment, there is still the potential for defensive dollar support, especially as confidence in emerging markets is also liable to fade, but the dollar will find it hard to gain strong support.

The dollar secured net gains as European currencies faltered again and there was asset allocation in favour of the currency as the Euro tested support below 1.4250.

The US consumer confidence data was even weaker than expected with a decline to 44.5 for August from a revised 59.2 the previous month which was the lowest reading since April 2009 and reinforced fears over the economic outlook, especially with increased pessimism over the employment outlook.

The latest FOMC minutes suggested that there was lively discussion at the last Fed meeting with a clear divergence in view. The dissenters were uncomfortable with a commitment to keeping low interest rates until 2013 and Kocherlakota emphasised his inflation concerns in a speech on Tuesday. In contrast, some members of the FOMC wanted further policy action at this time. The minutes confirmed the decision to hold a two-day meeting in September as indicated by Bernanke at the end of last week.

The latest ADP employment report registered private-sector job gains of 91,000 in August from a revised 114,000 previously. Given that government jobs have consistently declined over the past few months, there were continuing expectations of poor payroll growth in the Friday employment report.

There was some relief surrounding the latest US ISM manufacturing survey as it fell to 50.6 for August from 50.9 previously. Although this was the lowest figure since 2009, there had been expectations that the figure would drop significantly below the 50 threshold. There was some disappointment over the employment component which was the weakest since November 2009.

Euro

There will be expectations of a sustained downturn in the Euro-zone economy. This will be particularly dangerous for the Euro-zone as it would also increase pressures within the peripheral economies and put additional strain on the debt profile. There is likely to be a shift in ECB policies as there is little credibility in suggesting that interest rates are likely to increase again. The ECB will also be very important in supporting peripheral bond markets, but this is not sustainable in the long term. Political negotiations surrounding an expanded EFSF will also be watched closely. The Euro will be vulnerable to heavy selling if fears surrounding the banking sector increase.

The Euro was subjected to renewed selling pressure as confidence in the Euro-zone financial sector remained extremely fragile.

ECB President Trichet stated that underlying inflation risks were being re-assessed and that a new report would be available for the September ECB policy meeting. Trichet stated that inflation would remain above 2.0% in the short-term, but there was further speculation that there would be a downgrading of internal inflation forecasts which would also nullify any further talk of higher interest rates.

The latest PMI data was weaker than expected with the revised manufacturing index dipping to the lowest level since June 2009 with a reading of 49.0 from the flash 49.7 estimate which suggests that conditions deteriorated sharply late in the survey period.

The German government approved new powers for the EFSF, but there will be a tough battle to approve the legislation in the Bundestag given that several governing-party members are opposed to the changes. There were also increased fears that the complex rules surrounding the fund would prevent it responding effectively to a crisis.

There were further concerns surrounding the European banking sector with reports that many banks were effectively shut-out of international markets or were able to access funds for very short-term periods only. There was further buying of European peripheral bonds by the ECB, but the impact was less than that seen in previous days and it struggled to overcome the negative impact of weak demand in the latest Spanish auction. There was further speculation over a more dovish ECB policy next week as bank member Nowotny stated that there would be lower inflation in 2012.

There was another warning over the ECB policies from the German Bundesbank as underlying tensions remained high with further reports from the IMF-led mission to Greece that budget targets would be missed.

Sterling

Confidence in the economic outlook will remain extremely fragile in the short-term. The Bank of England will keep interest rates at extremely low levels and, although it is not likely to make a near-term move to boost quantitative easing, there is the possibility that this will be a medium-term option which will curb Sterling buying support. Sterling is also not well placed to secure substantial defensive inflows given underlying economic weakness and fragile banking sector. Weakness elsewhere may be effective in curbing heavy selling pressure.

Sterling retreated over the week with significant loses against the dollar as a dip in any safe-haven support for the UK currency coincided with fresh US demand. The Euro failed to hold its best levels as month-end demand faded.

The UK lending data remained subdued with a net GBP0.7bn increase in personal lending for July and money supply growth also remained lacklustre, although the mortgage approvals data was slightly stronger than expected. The latest CBI survey for services-sector activity recorded a sharp deterioration in confidence and orders for the third quarter and this will maintain fears over the economic outlook

The PMI manufacturing index weakened to 49.0 for August from 49.4 previously and this was the lowest reading since June 2009, although there was some relief that the release was not even worse. There will be continuing expectations of a weak economy, especially if there is any deterioration in the services-sector data.

The Bank of England will keep interest rates at extremely low levels and markets will watch any hints over quantitative easing very closely in the near term.

The Week Ahead

The financial sector will continue to be an important focus in the short-term with further speculation that liquidity and solvency will deteriorate further which could cause severe stresses within Europe. Currency regimes and management will also be a very important focus following the Swiss National Bank move to set a minimum rate against the Euro and there will be pressure for stronger international co-ordination.

Dollar

Confidence in the growth outlook will remain weak, especially after the depressed payroll reading and there will be greater doubts over exports given the international profile. The Federal Reserve will certainly maintain interest rates at very low levels and there will be a discussion of further possible measures at the FOMC meeting later in September. International risk conditions will also be extremely important for the dollar and fears over the growth outlook will provide defensive support. The dollar will also tend to gain support from stresses within the money markets and a structural dollar shortage, although there are tentative signs that these tensions may be peaking. Given the lack of viable alternatives, the dollar should be able to maintain a solid tone.

The US markets were initially sidelined by the US holiday and attention tended to be focussed on events within Europe during the week as the dollar continued to gain some defensive support as the trade-weighted index rose to 10-week highs.

Following the surprise employment data with zero employment growth for August, the ISM index for the services-sector was stronger than expected with a rise to 53.3 in August from 52.7 previously which provide some relief, although the underlying components were still fragile.

The US jobless claims data was little changed at 414,000 from 412,000 previously, but there was a big improvement in the trade deficit to US$44.8bn for July. Exports were at record levels and will provide some support to the third-quarter GDP data.

President Obama’s pledge of a US$447bn jobs package did not have a significant impact while Fed Chairman Bernanke repeated that the Fed would explore options for further economic support at the forthcoming FOMC meeting.

Euro

The evidence suggests that there will be a further deterioration in growth conditions in the short-term. As well as undermining sentiment, these stresses will also have an important negative impact on the peripheral economies which will make it even more difficult to escape from recession. The current policy structures are unsustainable even if the ECB provides some degree of relief with a more neutral policy. The debt situation and serious stresses within the banking sector will continue to represent very a very important threat to the Euro with a high risk that Greece will be forced to default or leave the Euro.

The Euro remained under pressure during the week as structural fears and an ECB policy shift undermined sentiment. The ECB announced that it had purchased EUR13.3bn in bonds in the latest reporting week from EUR6.7bn previously even though there was still an increase in yields. Benchmark Italian yields rose to above the 5.50% level with confidence also eroded by rumours of a credit-rating downgrade.

There were further stresses within the banking sector as the German Dax weakened to a two-year low while there was also a record amount of cash placed at the ECB and dollar Libor rates also continued to edge higher.

The German Constitutional Court ruled that the original May 2010 Greek bailout was not illegal under the constitution which provided some immediate Euro relief. The court also had important reservations and demanded that parliament should be given greater control and influence over the budget and bailouts.

The Italian Senate approved the amended austerity plan and the debate moved to the Lower House with tensions still high. Greek yields failed to decline significantly amid further concerns over the lack of progress on austerity measures. The German CSU parliamentary leader warned that a Greek exit from the Euro could not be ruled out.

As expected, the ECB left interest rates on hold at 1.50%. The ECB also presented fresh forecasts for the Euro area with modest downward revisions to growth and inflation estimates for 2011 and 2012 with the 2012 GDP range lowered to 1.3% from 1.7%. Trichet stated that the growth risks were now biased to the downside and there had been a significant change in ECB policy stance. Effectively, this meant that there would be no further interest rate increases with the bank moving to a neutral stance while markets priced in a fourth-quarter interest rate cut.

There were further fears surrounding the Euro-zone structural outlook as the Greek situation remained critical. There were further warnings from German and Dutch officials that Greece must meet the deficit-cutting targets in order to receive the next tranche of loan support. The Greek economy, however, contracted by over 7% in the year to the second quarter.

Sterling

Confidence in the economic outlook will remain extremely fragile in the short-term with the services-sector PMI data causing particular alarm. The Bank of England will keep interest rates at extremely low levels and, although it is not likely to make a near-term move to boost quantitative easing, it remains a medium-term option which will curb Sterling buying support. Unease surrounding the banking sector will continue and there will also be additional pressure for a shift in government policies. Give the debt profile, Sterling is also unlikely to secure significant defensive support.

Sterling remained on the defensive against the dollar as it dipped to 7-week lows below 1.60, but there was net support against the Euro with two-week highs near 0.87.

The UK PMI services-sector index fell very sharply to 51.1 for August from 55.4 the previous month. This was the sharpest decline for over 10 years and the lowest reading since the weather-induced dip to below 50 in December 2010.

There was a sharp deterioration in confidence and employment levels also continued to decline. The latest NIESR GDP estimate also showed a sharp slowdown in August to 0.2% from 0.6% previously which dampened expectations of a third-quarter recovery and maintained underlying fears surrounding the economy.

The MPC left interest rates on hold at 0.50% and the total amount of quantitative easing was also unchanged at GBP200bn. There was no statement with the policy decision. There had been some speculation that the bank would consider an increase in quantitative easing and Sterling rallied in relief that policy was unchanged.

The Week Ahead

The Euro-zone will inevitably be extremely important in the short-term. There will be additional liquidity support for the European banks which will lessen the risk of European contagion, although there will also be continuing speculation that there will be an imminent Greek default with European leaders looking to contain the contagion impact through increased support for the banking sector.

Dollar

The US economic trends have tended to be overshadowed by the Euro-zone stresses, but there will be a greater focus over the following week with the latest Federal Reserve meeting. There will be expectations that the Fed will look for more technical support for the economy in the form of a shifting bond maturities rather than increasing outright bond purchases. There will be further doubts surrounding the economy, especially with a continuation of weak manufacturing surveys and budget fears will increase again. The central bank operations will alleviate dollar shortages which will ease technical buying support for the currency, although there will still be defensive support on global economic fears.

The dollar was unable to hold its best levels during the week as measures to tackle European banking-sector stresses undermined defensive support with the Fed supplying increased dollar liquidity. US Treasury market continued to gain defensive support during the week. At one stage, benchmark 10-year yields fell to a record below the 1.90% level. From a longer-term perspective, there was further speculation over US reform of corporate taxes which could encourage a medium-term flow of funds back to the US and support the dollar.

The US retail sales data was slightly weaker than expected with no change for August while there was an underlying 0.1% increase for the month. The immediate data impact was limited with markets still focussed firmly on the Euro area. There were further expectations surrounding a relaxation of ECB monetary policy and yield spreads over the dollar narrowed to eight-month lows.

Subsequent US economic data offered no support to the immediate growth prospects. The New York manufacturing PMI index fell again to -8.8 for September from -7.7 previously while the Philadelphia Fed index also remained well below zero at -17.5 for the month. In addition, there was an increase in jobless claims to 428,000 in the latest week from 417,000 previously. There will be additional pressure on the Federal Reserve to take additional steps at the FOMC policy meeting next week.

Euro

The Euro-zone outlook remains extremely precarious as sovereign-debt issues continue to intensify. The Greek economy remains in freefall and there remains an extremely high risk of debt default and Euro exit, potentially very quickly. With growth conditions deteriorating, there will be fears that debt profiles in Italy and Spain will also continue to deteriorate, exposing them to a further contagion risk. There will be further fears over the banking sector and political divisions surrounding key issues such as Eurobonds will continue. The Euro will gain relief at times, but will find it very difficult to gain sustained support, especially as sovereign buying from Asia is liable to be lower.

The Euro recovered from its worst levels near 1.35 against the dollar as European officials looked to ease strains within the region. The Greek announcement that it would introduce fresh austerity measures also lessened immediate fears that the government would abandon the austerity programme and look to default instead. The Italian auction, however, was weaker than expected with 5-year yields rising to the highest level since the Euro’s inception in 1999 at above 5.6%, reinforcing fears the Italian debt profile would quickly move out of control.

The German and French governments pledged their support for Greece in a conference call, although there were no fresh measures announced. There were also setbacks surrounding the EFSF vote as the Austrian parliament blocked any fast-track vote to expand the European support fund and there were further political fissures within Germany.

There were further fears surrounding the Euro-zone financial sector as there were credit-rating downgrades for two French banks while two banks also accessed the emergency ECB dollar funding facility. There was a further increase in dollar Libor rates as tensions remained high.

The ECB and Federal Reserve, along with other major central banks, announced a new three-month dollar repo facility. The ECB will, therefore, be in a position to provide unlimited dollar liquidity to European banks with funds secured from the Federal Reserve. The moved eased fears over a dollar liquidity crisis within the European banking sector. There was an improvement in risk appetite as Euro-zone fears eased to some extent. The facility will also curb dollar demand in the open market which will tend to lessen US currency buying.

There was also speculation that the ECOFIN meetings on Friday would look to leverage the EFSF and give the ECB more buying power to purchase Euro-zone bonds. There was still a high degree of unease over the Euro-zone outlook with strong speculation that Greece would still default. German Chancellor Merkel also opposed the use of Eurobonds in very strong terms.

Sterling

Confidence in the economic outlook will remain extremely fragile in the short-term with growth liable to deteriorate further, especially with Euro-zone vulnerability dampening exports. There will be further speculation over additional quantitative easing and there will also be speculation that there will be a shift in government policies to slow the pace of fiscal adjustment. Sterling should still be able to gain some degree of protection from its position outside the Euro-zone with some flow of funds into bonds, although this trend could reverse very quickly. Sterling is unlikely to gain strong support given the fundamentals.

Sterling was weaker against the dollar during the week, although it did recover from eight-month lows near 1.57 while the Euro recovered to above 0.87.

The latest consumer inflation data was in line with market expectations as the headline rate edged higher to 4.5% from 4.4% as utility prices continued to increase. Sterling failed to gain any significant support from the data as there is no prospect of the Bank of England tightening monetary policy. The trade data remained disappointing with the deficit unchanged at GBP8.9bn for July.

MPC member Posen called for additional policy action in the form of quantitative easing, although he called for international action and not just measures in the UK.

The headline UK unemployment claimant count was slightly better than expected with an increase of 20,300 for August after a revised 33,700 increase the previous month. In contrast, the 3-month unemployment figures were weaker than expected as government employment fell sharply. There was a 0.2% decline in retail sales for August compared with a 0.2% gain previously with the underlying trend flat.

Bank of England MPC member Weale stated that the risks of another recession had increased while fellow member Bean commented that inflation was set to decline in 2012. There was further speculation that the Bank of England would eventually move to sanction additional quantitative easing.

The Week Ahead

Fears over the Euro-zone and global economy is likely to remain dominant in the short-term with a particular focus on the banking sector as underlying sentiment remains extremely fragile. There will also be fears that Europe in particular will be unable to find the necessary policy responses. While risk appetite remains weak, there will be further defensive dollar support.

Dollar

The US economy is likely to remain weak in the short-term as manufacturing stresses continue with consumer spending unlikely to secure strong gains. In this environment, the Federal Reserve will keep interest rates at extremely low levels and will consider further quantitative action. The underlying budget position also remains precarious. International trends will tend to dominate in the very short-term at least and there will be further important defensive support from a lack of confidence in global markets. There will be reduced reserve diversification away from the dollar and there will also be a flow of funds into the US currency if emerging markets continue to weaken.

The dollar secured important support during the week as confidence in the global economy deteriorated. This triggered a fresh flow of defensive flows into US Treasuries and flows into the US currency tended to accelerate as emerging markets came under heavy selling pressure. The dollar index pushed to an 8-month high as fear dominated during the middle of the week

Attention returned to the Federal Reserve later in the US session on Wednesday with the latest FOMC statement. In broad terms, the Fed met market expectations with the announcement of ‘operation twist’. The Fed will buy US$400bn in longer-dated securities in the period until mid 2012 through the selling of shorter-term securities.
There was no introduction of further quantitative easing at this stage with the Fed keeping all policy options open as it remained generally downbeat on the economic situation. Three FOMC members dissented from the decision.

Equity markets fell sharply following the FOMC meeting and this also triggered a sharp deterioration in risk appetite which pushed the dollar sharply higher.
The US existing home sales data was stronger than expected at 5.03mn for August. It will still be difficult for the dollar to gain any significant support on yield grounds, especially with the Fed acting to keep long-term interest rates down.

Euro

The Euro-zone outlook will remain extremely precarious in the short-term. Greece may be able to secure additional aid which would keep the economy afloat for a few weeks, but this is far from assured given that domestic opposition to austerity will increase. A default also remains inevitable in the medium term. There will be further concerns surrounding the Italian economy and the banking sector will also remain a critical focus. Measures to recapitalise the banks would provide important support for the Euro. There will, however also be strong pressure for the ECB to cut interest rates which would undermine Euro support. In this environment, the currency is unlikely to secure a significant recovery.

The Euro was subjected to further selling pressure as fears surrounding the sovereign-debt crisis and banking sector increased. The Euro dipped to 8-month lows near 1.34 before some stabilisation.

There were increased political divisions within the Euro area with notable tensions in Germany and Greece. There was evidence of divisions within the Greek cabinet over economic policies while the government also floated the possibility of a referendum on Euro-zone membership in order to strengthen the government’s mandate and there were very strong expectations of an eventual default.

There was some relief as the government pledged to strengthen austerity measures through spending cuts with reductions in public-sector wage costs a key focus. There were still concerns whether the government would be able to deliver the austerity measures given internal divisions and popular discontent.

There were also further fears surrounding the European banking sector following reports that Chinese banks had withdrawn credit lines while dollar Libor rates continued to increase slowly and fears then escalated from mid week.

There were also continuing fears surrounding the banking sector as underlying stresses persisted. The IMF estimated that at least EUR200bn in fresh capital needed to be raised and there were persistent doubts surrounding the French banks in particular. There were also rumours that Austria could face a credit-rating downgrade due to the heavy burden of credit derivatives within the banking sector.

The German ZEW business confidence index weakened to -43.3 for September from -37.6 previously, although this was slightly better than expected and there was also some cautious optimism from the ZEW institute that conditions might be stabilising.

There was a further deterioration in the Euro-zone PMI indices with the flash manufacturing index weakening to 48.4 for September from 49.0 previously while the services sector also weakened to below the 50 level for the first time in two years. There was increased speculation that the ECB would need to take emergency action to cut interest rates in an attempt to boost confidence.

Sterling

There will be further concerns over the UK economy in the short-term with weak consumer spending compounded by a much less favourable global outlook. There will be strong pressure on the Bank of England to sanction further quantitative easing in an attempt to boost demand and real interest rates will remain very negative. Any dip back into recession would also fuel additional debt and budget fears which would undermine the currency. Sterling will be much more vulnerable to selling pressure if there are renewed fears over the banking sector. There could still be some protection from the UK position outside the Euro-zone, but Sterling is unlikely to make much headway.

Sterling weakened to 12-month lows against the dollar during the week as the US secured wider support while Sterling was unsettled by domestic fears and renewed fears over the banking sector.

The IMF lowered its growth forecasts which had a negative impact on sentiment. The 2011 estimate was cut to 1.1% and, more damagingly, the 20012, forecast was cut to 1.6% from 2.3% previously. There was also further market discussion surrounding the FT assessment that the structural budget position was weaker than expected.

The Bank of England minutes recorded a 9-0 vote for unchanged interest rates at the September MPC meeting and there was an 8-1 vote for quantitative easing to be held at GBP200bn as Posen again voted for an expansion. The bank was generally pessimistic over the economic outlook and several members did move towards voting in favour of additional quantitative easing. There were, however, important reservations over fresh action when inflation was so far above the 2.0% target.

Markets concluded that further quantitative easing was likely over the next few meetings and this pushed Sterling sharply weaker. The latest government borrowing data was weaker than expected at GBP13.2bn for August, although there were downward revisions to previous data. There was further pressure for the government to slow fiscal tightening given the deteriorating economic outlook.

The Week Ahead

Fears surrounding the Euro-zone and global economy will remain extremely important in the short-term. Signs of greater urgency by Euro-zone governments has provided some relief to risk appetite, but there are still major barriers to a durable solution and there will also be fears that the global economy is deteriorating with important stresses in Asia. There is unlikely to be much in of the way of sustained in improvement in risk appetite.

Dollar

The US data releases have remained uninspiring at best and there will be continuing fears that the economy is moving back into recession. The Federal Reserve will maintain interest rates at extremely low levels and will look at additional policy action, although the monetary data should prompt caution. There will also be further medium-term stresses surrounding the budget outlook. The global economic outlook will also be watched very closely and there will be a further lack of confidence which will continue to trigger defensive dollar demand, especially if there is no improvement in the Euro-zone financial crisis.

The dollar secured strong advances at times, but was unable to hold its best levels as there had already been a substantial speculative shift in the US currency’s favour and the trade-weighted index fell from 8-month highs.

The US consumer confidence index was little changed at 45.4 for September from 45.2 previously and remained trapped near historic lows while house prices fell 4.1% in the year to July according to the Case-Shiller index while jobless claims fell to below 400,000 in the latest week.

The US durable goods orders data was marginally weaker than expected with a 0.1% decline for August, although the impact was limited as markets continued to concentrate on risk appetite. There was a sharp Wall Street decline in late trading on Wednesday which undermined confidence and triggered fresh dollar demand, but it was unable to hold gains.

The latest IMM positioning data recoded the largest net long dollar position since July 2010 and a further increase in Euro short positioning which lessened the potential for additional dollar buying.

Euro

The Euro-zone outlook will remain extremely precarious. Greece may be able to secure the next loan tranche which would keep the economy afloat for a few weeks, but a default remains inevitable in the medium term. There will be further concerns surrounding the economy as a whole and the banking sector will also remain a critical focus. Political tensions, notably in Germany, will be extremely important as barriers to more aggressive measures will be formidable. There will still be strong pressure for the ECB to cut interest rates which would undermine Euro support. In this environment, the currency is unlikely to secure a strong recovery, but bank recapitalisation would be supportive.

During the week, there was greater urgency by Euro-zone leaders following the weekend IMF meetings had this had some positive Euro impact. There was increased speculation that the ECB would restart its covered-bond issuance policy to provide additional liquidity. There was also further speculation that the EFSF would be leveraged through the ECB to provide greater market impact. There was a strong rally in European financial share prices as panic surrounding the banking sector eased.

Underlying confidence remained extremely fragile, especially as there are extremely important splits within governments and central banks. The German Finance Minister stated that there was no need to increase the rescue fund. There were also very strong comments by Bundesbank head Weidmann against using the ECB to fund EFSF bond purchases and there will certainly be further major policy divisions.

There was some relief that the latest German IFO index fell less than expected which suggests some resilience in the industrial sector. Steady German consumer confidence and firmer money-supply growth provided some Euro support.

Markets were relieved that the IMF-led troika would resume its negotiations over Greek fiscal policy on Thursday with increased optimism that there would be a positive recommendation that the next loan tranche should be approved. There was also relief that the Finnish parliament voted to approve expanded EFSF powers.

The German parliament also passed the EFSF legislation on Thursday with Merkel able to secure a narrow majority of her own coalition. There was still a high degree of uncertainty over the situation, especially as there were reports that the German government was looking to re-negotiate the terms of the second Greece bailout package, fuelling fears over policy divisions. More importantly, underlying fears will persist, especially as the EFSF even in its stronger form will not be able to stabilise the debt situation and there will be demands for even more aggressive actions. The Euro was able to stabilise above 1.36 against the dollar.

Sterling

There will be further concerns over the UK economy in the short-term with weak consumer spending compounded by a much less favourable global outlook. There will be strong pressure on the Bank of England to sanction further quantitative easing in an attempt to boost demand and a move is certainly likely during the fourth quarter. Sterling will be much more vulnerable to selling pressure if there are renewed fears over the banking sector. There could still be some protection from the UK position outside the Euro-zone, especially if there are measures to protect the financial sector as this would also benefit the UK banks but Sterling is unlikely to make strong headway.

Sterling found firm support on dips below 1.5450 against the dollar, advancing to highs around 1.57, and held its ground against the Euro, although Sterling was generally out of the spotlight.

The UK BBA mortgage data was slightly stronger than expected which provided some degree of confidence surrounding the housing sector, although international developments remained dominant. The economic data did not have a significant impact with the CBI retail survey weakening to -15 in September from -14 the previous month. Bank of England MPC member Miles stated that he was close to voting for additional quantitative easing in September, echoing remarks made by Broadbent the previous day.

Sterling gained support from a strong recovery in banking stocks and there were increased hopes that the UK would effectively get a free ride from any Euro-zone rescue attempts. Any increased support for the European banking sector would also tend to improve the UK banking-sector outlook. The Swiss National Bank announced that it would increase the Sterling proportion of its reserves.

The latest Bank of England survey reported some improvement in credit conditions during the third quarter, but there was still a high degree of uncertainty over the situation and doubts whether the improvement would be sustained which maintained an underlying lack of confidence.

The Week Ahead

Central banks have managed to stabilise conditions to some extent with risk appetite recovering slightly. There will still be a high degree of unease and fear over the outlook, especially with persistent tightness in money markets and expectations of a weaker Chinese economy. There is still liable to be a net flow of funds away from emerging markets and the Euro-zone which will help support the US dollar with the European currencies unlikely to make strong headway.

Dollar

The short-term dollar outlook will continue to be influenced strongly by trends in risk appetite, the banking sector and degrees of confidence in the global economy. There is still likely to be a net flow of funds into the US currency, especially if emerging markets weaken further. There will continue to be a lack of confidence in the US fundamentals and there will be speculation over additional Federal Reserve quantitative easing if there is evidence of a further deterioration in growth. On a short-term view, the dollar should be able to maintain a firm tone given international credit-related stresses.

The dollar continued to gain net support from capital flows out of emerging markets and a lack of confidence in the Euro. It was unable to hold its best levels as risk appetite staged a recovery with Euro support below 1.32.

As far as the US data is concerned, the ADP survey recorded net private-sector job gains of 91,000 for October which was marginally higher than expected, although the impact was limited, especially as the latest Challenger data recorded a sharp increase in layoffs. The latest US jobless claims data recorded a small increase to 401,000 in the latest week from 395,000 previously.

The US ISM index for the non-manufacturing sector recorded a slight decline to 53.0 from 53.3 the previous month. There was relief that that a severe deterioration was avoided, but the employment index dipped to below 50 for the first time in over 12 months which dampened confidence towards the Friday payroll data.

Fed Chairman Bernanke remained extremely cautious surrounding the US economy with comments that it was close to faltering. He also stated that all options would be kept under consideration, although there were no immediate plans for further quantitative easing. There were further divisions within the Federal Reserve.

Euro

The Euro-zone leaders at least have some form of strategy to navigate the extremely turbulent waters, but the underlying outlook will remain extremely vulnerable in the short-term. Euro-zone leaders will look to bolster the banking sector in the short-term while keeping Greece afloat for a little longer. This strategy will be extremely dangerous, especially as there are already very important stresses within the banking sector, illustrated by the collapse of Dexia. There will be strong pressure for the ECB to lower interest rates to underpin demand. There is still a high risk that Euro-zone leaders will not be able to contain the contagion effect, especially given the important political tensions.

The Euro was subjected to further selling pressure during the week before staging a recovery as the currency resisted further losses and risk conditions stabilised.

There was a continuing lack of confidence in Greece with strong expectations of a medium-term default, especially after any decision on the next loan payment was delayed until November. The Greek government stated that it had enough funding until mid-November, but there were still strong expectations of a much bigger private-sector debt write-down as part of a repackaged rescue programme.

There were further fears surrounding the banking sector with the Belgian authorities announcing a fresh support package and effective nationalisation for Dexia There was further speculation over a recapitalisation of European banks which helped underpin the currency. German Chancellor Merkel suggested that the EFSF could be used to help support the banking sector while she reaffirmed that Greece should stay in the Euro. IMF European Head Borges suggested that the IMF could buy Euro-zone peripheral bonds, although this was played-down by Washington

The ECB left interest rates on hold at 1.50% following the latest council meeting. In the press conference following the decision, Bank President Trichet, in his final meeting announced that the ECB would introduce long-term repo operations of 12 and 13-months to help bolster liquidity. The bank would also re-start the purchase of covered bonds to boost confidence.

Trichet stated that downside risks to the economy had intensified, but he was very anxious not to make a commitment to lower interest rates. There was also a clear reference to the rate decision have been a consensus which indicated that some members had pushed for interest rates to be lowered. There will be concerns that incoming President Draghi will find it difficult to cut interest rates at his first meeting.

Euro-group head Juncker stated that the EFSF couldn’t deal with an Italian rescue and underlying sentiment remained extremely fragile. The Euro initially weakened to test support below 1.3250 against the dollar, but it then rallied and there was an important covering of short positions as the currency as it pushed to highs near 1.3450.

Sterling

There will be further concerns over the UK economy with fears over domestic vulnerability compounded by international fears. Credit concerns will certainly remain a very important short-term feature, especially with the Bank of England taking a ore aggressive stance by expanding quantitative easing. There is an important risk that this move will serve to further damage confidence. There will also be fears that the banking sector will be exposed to fresh losses if the Euro-zone situation deteriorates further. There is still the possibility of defensive flows into the UK bond market given that the UK will not default.

After mixed data releases, the Bank of England dominated the second half of the week. The UK PMI manufacturing index rose to 51.1 in September from 48.9 previously which helped alleviate immediate fears surrounding the industrial outlook. The PMI services-sector data was stronger than expected with an recovery to 52.9 for September from 50.5 previously which eased fears over a rapid deterioration in the economy, although business confidence fell to a 30-month low.

There was no surprise with the interest rate decision as rates were left on hold at 0.50% for the 28th consecutive month. There was, however, a surprise with the asset-purchases target as the MPC sanctioned a further GBP75bn increase to GBP275bn. A minority of analysts had expected an increase, but most forecasts were centred on a GBP50bn increase. The Bank of England stated that an easier policy was required to meet its medium-term inflation targets, comments which may come as a surprise given that inflation is more than twice the 2.0% target.

Bank Governor King was very pessimistic surrounding the UK and global economy in media comments with the UK outlook damaged by a slower global economy and by the Euro-zone turmoil. He also stated that the global economy faced its worst crisis. There will be some fears that the bank has effectively panicked and the move may, therefore, not be effective in boosting confidence.

Sterling hit a 14-month low against the dollar, dipping to lows around 1.5270 before staging a sizeable recovery to near 1.5450 as the US currency came under pressure. Standard & Poor’s maintained its AAA credit rating for the UK.

The Week Ahead

Global risk appetite has stabilised with the Euro-zone attempts to boost the banking sector a very important market influence. Leaders still have a very important task in actually delivering plans to strengthen the banking sector and managing a Greek default. It will, therefore, still be very difficult to secure a sustained improvement in risk appetite, especially as there are still serious vulnerabilities in the global economy as markets consider the risks of a prolonged downturn.

Dollar

The latest US data has registered some degree of relief as jobless clams have remained at lower levels and there was a firmer than expected employment report. Even if recession fears ease slightly, there will still be expectations of very weak growth and there will still be pressure on the Federal Reserve for further quantitative easing. Trade tensions will also be dangerous for the currency. The dollar will continue to gain some protection from elevated levels of Libor rates and fears over the Euro-zone banking sector will also provide significant support, especially if there is a flow of funds out of emerging markets. Overall, the dollar should be able to resist sustained selling pressure in the short-term.

The dollar had a weaker tone during the week as defensive demand for the currency eased following a general improvement in risk appetite. The US currency weakened to lows beyond 1.38 against the Euro and also fell sharply on a trade-weighted basis.

The Federal Reserve minutes from September’s meeting confirmed that there was a lively discussion surrounding the economy and appropriate policies. There were fears over the growth outlook, but members were not expecting economic contraction. There was a minority of FOMC members pushing for further quantitative easing while the majority view was to keep policy options open. Plosser voiced his opposition to further easing, both in the minutes and in a speech on Wednesday.

The dollar was undermined by an improvement in risk appetite and trade tensions with China also had a negative impact on the currency. The US trade deficit was marginally lower than expected, unchanged at US$45.6bn for the month as exports were marginally lower. The monthly trade deficit with China increased to a record US$29bn which will tend to inflame congressional anger over the Chinese yuan and trade tensions remained an important influence. Elsewhere, jobless claims were little changed at 404,000 in the latest week and provided some underlying dollar support.

Euro

The Euro-zone leaders will continue their battle to find credible answers to the sovereign debt crisis and will have an extremely narrow path to follow both economically and politically as popular opposition to any further bailouts increases. Political barriers to action remain high and Greece will have to default in the medium term which will pose additional risk to the banking sector. There will also be fears that ECB independence will be compromised which will undermine the medium-term currency outlook. The Euro is unlikely to be a strong currency if it continues in its present form.

The Euro rallied strongly during the week as there was greater optimism that there could be a credible solution for the sovereign-debt crisis.

The EU Commission also announced that the Summit originally scheduled for October 17th would be delayed by six days to give leaders more time to finalise plans.
There was further speculation that much larger private-sector Greek debt write-downs would be required, although this would also increase bad-debt positions within the Euro-zone banks. There were further concerns over the banking sector following Dexia’s collapse and a warning from Austria’s Erste Bank.

There was a slight easing of financial strains as the Euribor-OIS spread narrowed during the week. In contrast, dollar Libor rates continued to increase slowly and there was also an increase in deposits held at the ECB to a record level which suggested that there was still a lack of underlying trust in the banking sector.

ECB president Trichet stated that systemic risk to the Euro-zone had increased and was extremely cautious over the sovereign-debt situation. He also stated that collateral could not be accepted from defaulted states in a clear reference to Greece. Trichet also stated that the Euro was in no danger in an attempt to ease market tensions.

The Troika report on Greece stated that the 2011 budget targets would be missed and that there would also need to be further action to meet deficit targets from 2013 onwards. The troika recommended that the November loan payment should be made with German officials warning that approval was not automatic.

There was increased optimism surrounding the Euro-zone as the week progressed with hopes that there would be comprehensive measures to strengthen bank capital. The EU Commission called for a co-ordinated approach, but there was little in the way of detail and short covering was still a key focus.

There was further speculation that there would be a much deeper restructuring of Greek debt with the possibility of haircuts of at least 60%. The ECB warned that any move to force private bondholders to accept bigger losses could weaken the banking sector and cause further stresses. There was more positive news during the US session on Thursday as Slovakia finally approved changes to the EFSF.

Sterling

There will be further concerns over the UK economy with fears over domestic vulnerability compounded by international fears. Credit concerns will certainly remain a very important short-term feature given stresses within the banking sector and the revival of quantitative easing will also continue to have a negative impact on the UK currency. There will be some support from Sterling’s position outside the Euro-zone and there will be scope for reserve diversification into the UK currency. Sterling is still unlikely to make much headway from current levels given the debt profile.

Sterling found support below 1.56 against the dollar and rallied hard during the European session as the dollar was subjected to wider selling pressure. The UK currency peaked just above 1.5780 before correcting slightly weaker while the Euro peaked just above 0.8780.

The latest BRC retail sales report recorded a 0.3% like-for-like increase in sales while the RICS house-price index was unchanged at -23% which did not suggest a major trend change within the economy. The headline claimant count data was slightly better than expected with an increase of 17,500 for September following a revised 20,300 increase previously. There was, however, a further increase in youth unemployment and the unemployment rate rose to a 17-year high of 8.1% from 7.9%.

The latest UK trade data was better than expected as the goods deficit narrowed to GBP7.bn for August from a revised 8.2bn the previous month. Exports were at a record level which triggered a slightly more optimistic stance towards the economy despite fears over consumer spending. Any rebalancing in growth towards exports would be vital in improving the medium-term outlook.

There was speculation that the UK bank ratings would be downgraded by Fitch and there was also a market rumour of a sovereign downgrade. Sterling proved resilient despite the negative speculation with some support on speculation over reserve diversification in favour of the UK currency.

Ενας απο τους μεγαλυτερους κερδοσκοπους συναλλαγματος , ο κ. John Taylor , επικεφαλης της FX Concepts , του μεγαλυτερου hedge funds στον κοσμο , που πονταρει στις ισοτιμιες των νομισματων , παρομοιαζει το ευρω σαν ενα κοτοπουλο που του εχουν κοψει το κεφαλι.
Για λιγα λεπτα συνεχιζει να τρεχει γυρω - γυρω ακεφαλο και τελικα πεθαινει ...

Πηγη : Ο Κερδοσκοπος

The Week Ahead

Euro-zone developments will remain extremely important in the short-term with crucial EU and G20 Summits due over the next two weeks. If leaders fail to stem the underlying contagion risk and stabilise the banking sector, then fears over a global recession will intensify. The principal feature is likely to be a sustained increase in volatility across all the major currencies, especially with banks looking to bolster balance sheets through capital repatriation.

Dollar

There will be some continuing relief over the latest US data, especially if an improvement in the housing sector can be sustained, and recession fears are liable to ease slightly. The Federal Reserve will maintain an extremely loose monetary policy and there will still be speculation over further quantitative easing. Global developments will remain extremely important in the short-term and there will be defensive dollar demand as banking-sector funding worries persist. Ironically, the US currency may lose ground if the US data improves as there will be reduced fears over a global downturn. Nevertheless, the dollar should retain a broadly firm tone in the very short-term.

The dollar was subjected to choppy trading conditions during the week as it attempted to regain ground following sharp losses the previous week, but the performance was never entirely convincing as support was fragile with limited trade-weighted gains.

The housing data was stronger than expected with a gain to 0.66mn for September from a revised 0.57mn previously and the NAHB housing index also strengthened.
The headline consumer prices index rise was in line with expectations at 0.3% while the core reading was slightly lower than expected at 0.1%. The Fed’s beige Book generally reported that modest growth continued during September, although some districts were slightly more optimistic.

The New York manufacturing PMI index weakened again to -8.5 for October from -3.9 the previous month and this was the fifth successive figure below zero. Jobless claims falling 6,000 to 403,000 in the latest week while there was a sharp recovery in the Philadelphia Fed index to 8.7 for October from -17.5 previously. Although existing home sales weakened slightly and the tone remained cautious, there were increased hopes that the economy could avoid recession.

There were further internal Federal Reserve stresses, but indications continued to suggest that policy would remain extremely loose over the next few months.

Euro

There will be pressure to restructure the Greek bailout package, recapitalise the banking sector and strengthen the EFSF. There will be a high degree of political stresses, especially within Germany which will make Summit agreement difficult and increased debt write-offs for Greece will also be contentious. There will be strong pressure for a cut in ECB interest rates and there will also be fears that the ECB’s longer-term credibility will be damaged further with incoming president Draghi facing an extremely difficult task. The Euro could gain some degree of support from capital repatriation by Euro-zone banks and high volatility is likely to remain the principal feature.

Euro volatility was a key feature during the week as there was strong buying support on retreats. There was a suspicion that European banks were repatriating capital which boosted the currency and it found support near 1.3650 against the dollar.

As far as the economy is concerned, the Bundesbank warned that the outlook had deteriorated further for the fourth quarter. The latest German ZEW index weakened to a 34-month low of -48.3 from -43.3 the previous month and the Institute warned that Germany could already technically be in mild recession.

Italian bond yields continued to rise and approached the 6.0% level. Moody’s downgraded Spain’s credit rating for the third time sine June 2010. There were further uncertainties surrounding France’s AAA credit rating after it as put on review by Moody’s as French-German yield spreads widened to record highs.

Negotiations over the EFSF continued ahead of the planned Sunday EU Summit with a particular focus on disagreement between France and Germany. The French government still wants the EFSF to be made into a bank and for the ECB to play an increased role in providing guarantees and using its balance sheet to boost the fund. There is strong German opposition to this, not least because Chancellor Merkel would face strong opposition from within parliament.

France insisted that the Summit should go ahead rather than be postponed and, instead, there is likely to be a second meeting, probably on Wednesday 26th. There was also still no agreement on increasing the ‘voluntary’ haircuts on private-sector Greek debt holdings with France resisting bigger adjustments due to the risks this would pose to the banking sector.

The troika report on Greece was finally published and the IMF concluded that the situation was more difficult than expected as a deeper recession put further downward pressure on tax revenues. The troika still recommended that the next loan tranche should go ahead as planned as Greece approved austerity measures.

Sterling

There will be further concerns over the UK economy as underlying consumer spending is likely to remain under pressure even if headline retail sales hold steady. Real interest rates will remain extremely unattractive as the Bank of England continues to expand bond purchases. The banking sector will be extremely important in the short-term and there will be further fears that additional bailouts will be required. There will also be the threat of capital withdrawals from the UK as Euro-zone banks increase capital ratios. In this context, Sterling could suddenly be subjected to heavy selling pressure.

Sterling was generally resilient during the week against both the dollar and Euro as the UK gained support from a position outside the Euro-zone.

The consumer inflation data was stronger than expected with an increase in the headline rate to 5.2% from 4.5% previously. This equalled the highest rate seen over the past 20 years. Despite spiking briefly, Sterling was generally weaker following the data. Markets assumed that there would be no policy response from the Bank of England, especially as it is expecting the inflation rate to fall sharply in 2012.

The latest MPC monetary policy minutes recorded 9-0 votes both for the interest rate and the quantitative easing decisions. There was a marked change of tone as global and domestic economic fears increased. There had been some discussion whether to increase the bond buying of programme by GBP100bn rather than GBP75bn.

The latest retail sales data was stronger than expected with a 0.6% headline increase for September following a revised 0.4% decline the previous month. There were still fears surrounding the outlook, especially as the Nationwide consumer confidence index fell to near record lows of 45 for October.

The UK and Euro-zone banking sectors remained an important focus. There will be speculation that Euro-zone banks will pull funds out of the UK in order to bolster capital ratios and this would risk further serious damage to the UK economy.

The Week Ahead

The EU Summit has managed to ease immediate threats surrounding the Euro-zone debt crisis and improved risk appetite which will undermine short-term defensive demand for the US currency. There are still very important vulnerabilities surrounding the Euro-zone and the global economy as a whole and tensions could intensify again quickly given the debt dynamics and political pressures.

Dollar

The US data as a whole continues to suggest that the economy is achieving a path of weak growth, but there will certainly be fears over the consumer spending outlook, especially with confidence extremely weak. There is no possibility of the Federal Reserve tightening policy and there will be further speculation that another round of quantitative easing could be announced. The dollar, therefore, remains in a weak position to gain on yield grounds, although the valuation issue is certainly more supportive. Degrees of risk appetite and defensive demand will remain very important in the short-term and an easing of fear surrounding the Euro-zone will curb US currency demand. There will still be fears surrounding the global economy which should provide some dollar protection.

The dollar was subjected to substantial selling pressure during the week as a whole as defensive demand for the US currency dipped amid an improvement in risk appetite.

The US economic data was mixed over the week and did little to inspire confidence. Consumer confidence dipped sharply to 39.8 for October from 46.4 the previous month. This was the lowest figure since March 2009 and increased fears that the economy was sliding back towards recession even though recent data had been slightly more encouraging. The headline US durable goods report was weaker than expected with a 0.8% monthly decline, although there was a core 1.7% increase.

Fed Governor Dudley maintained a generally dovish tone in comments on Monday, but he did not suggest immediate quantitative easing. Underlying speculation that there could be further Fed action did limit any support for the dollar with the FOMC policy meeting due next week

Subsequent data was slightly better than expected with third-quarter GDP growth of 2.5% from 1.3% previously while jobless claims fell slightly in the latest week to 402,000 from 404,000. The data will help underpin confidence to some extent, but there will still be a high degree of unease over the US fundamentals and the dollar will remained dependent on defensive support to make headway, especially given the shift in yields. This risk was illustrated by a sharp drop in overseas US Treasury bonds in the latest reporting period.

Euro

The EU Summit has removed the threat of a short-term disorderly collapse in the Euro area with relief that there has been agreement surrounding a revised package for Greece. There will still be a high degree of unease over the situation, especially as details still have to be worked out. There was a similar feeling of relief following the July deal on Greece which disappeared very rapidly and confidence is again liable to fade quickly, especially if the economy continues to deteriorate. There will be strong pressure on the ECB to cut interest rates and political tensions could return extremely quickly to limit Euro support.

The Euro was subjected to choppy trading, but was able to secure strong net gains as fear declined and it pushed to a seven-week peak near 1.4250 against the dollar.

Following the first Summit meeting on Tuesday, markets were buffeted by rumours ahead of the second meeting. Volatility spiked on Tuesday as there were reports that the ECOFIN meeting also scheduled for Wednesday had been cancelled. There was some initial confusion with fears that the actual Summit scheduled for later on Wednesday had been postponed. Rumours of disagreement among key leaders pushed the Euro to lows close to 1.38 before a recovery.

In the event, leaders secured slightly more than had been expected by markets. There was agreement to increase core capital ratios within European banks to 9% by 2012 while the EFSF fire-power would also be increased to around EUR1.0trn through leverage, although precise details had yet to be worked out.

There was some surprise and relief as leaders agreed on a notional ‘voluntary’ 50% restructuring of private-sector Greek debt while there would be a revised EUR130bnsecond loan package for Greece. The IIF agreed to the restructuring after being told that the alternative would be a full-scale hard default.

There was a further improvement in risk appetite following the EU Summit as equity markets rallied and there were particularly sharp gains for the banking sector. There was important relief that leaders had managed to stave-off the immediate threat of a Euro collapse which encouraged a closing of short positions.

There was still concern over the lack of detail in the plans and fundamental doubts will continue. The ECB remains concerned over the mechanisms for expanding the EFSF fire-power, fearing the implications of increased leverage and there will also be very important political doubts. There were doubts within Germany and there were also further protests within Greece as the implications of continued austerity with fears that recession conditions would continue.

Sterling

There will be further concerns over the UK economy as underlying consumer spending is likely to remain under pressure given the substantial pressures on incomes. The Bank of England has clearly indicated that it will retain an aggressive policy of expansion even with inflation at elevated levels and real yields remain extremely unattractive. There will be some short-term relief surrounding the banking sector which should tend to lessen the threat of capital outflows, although the underlying position is liable to remain unstable and pressures could return quickly.

Sterling moves were dominated by global-market trends and risk appetite even though underlying sentiment towards the UK economy remained weak. Sterling weakened against the Euro, but pushed to six-week highs above 1.61 against the dollar.

The latest UK consumer confidence data recorded a decline to -32 for the latest month from -30 previously which was a 32-month low as sentiment remained weak. Although there was a slightly stronger reading for the latest CBI retail sales survey, it remained in negative territory at -11 from -15 previously and there were further doubts surrounding the spending outlook. The Bank of England is continuing to take a gloomy tone on prospects as incomes remain under pressure.

There was a better than expected current account figure with the quarterly deficit held to GBP2.0bn from a revised GBP4.1bn. Although the data is volatile, there was some optimism that the UK funding environment was not as bad as expected.

There was relief surrounding the UK banking sector following the EU Summit as there was a sharp gain in equity markets. There may be reduced fears surrounding the threat of capital flows out of the UK financial sector, at least in the short-term, although there will also be unease surrounding the medium-term outlook as European banks still have to raise substantial amounts of capital.

The Week Ahead

The Euro-zone debt crisis has returned to dominate the headlines following Greek referendum announcement and subsequent withdrawal. Tensions will remain extremely high with increased fears surrounding Italy maintaining severe doubts surrounding the Euro-zone as a whole. Ironically, capital repatriation fears could support the Euro initially, but the underlying foundations are liable to weaken further as capital flight from the periphery intensifies. High volatility is likely to be a key feature.

Dollar

There will be some further hopes that the US economy can avoid recession, but underlying confidence will inevitably remain very fragile. The Federal Reserve also remains concerned over the outlook and there will be further speculation that the central bank will sanction additional quantitative easing. The underlying fundamentals also remain weak given the severe budget stresses. International trends will remain extremely important in the short-term and there will be defensive dollar demand at times, especially if there is evidence of sustained deterioration in the global economy and a firm tone is likely. Repatriation flows into Europe could, however, unsettle the currency to some extent.

The dollar secured significant net gains for the week against the Euro and gained strongly at times when risk aversion increased with a peak near 1.3650, although the underlying performance still lacked conviction.

The US PMI index for manufacturing dipped to 50.8 for October from 51.6 previously and there were mixed readings for sub-components as orders improved and inventories fell while there was a sharp decline in prices.

The Fed announced that policy was on hold following the latest FOMC meeting. The message of stability allowed Bernanke to secure a unanimous vote, especially as there was some discussion on amending language putting dates on how long policy would be on hold.

The third-quarter growth was described as stronger, but the Fed still pointed to downside risks for the economy and inflation. It will, therefore, stand ready to safeguard the economic recovery with further buying of mortgage-backed securities.

The decision not to sanction any immediate easing helped support the dollar with gains compounded by Euro uncertainty.

Subsequently, jobless claims falling to 397,000 in the latest week from 406,000 previously while the PMI services index was little changed at 52.9.

Euro

Euro-zone tensions will remain extremely high in the short-term. Even though a Greek referendum looks to have been avoided, the underlying political situation remains precarious and there will be further speculation over a Greek Euro exit. The main danger to the Euro will come from the contagion threat, especially with increased fears surrounding Italy. So far, the ECB is continuing to resist an increased financing role, increasing the risk of disorderly capital outflows. Ironically, the Euro cold actually strengthen initially in the face of increased fear as capital repatriation by the banking sector would be liable to increase. Nevertheless, the underlying outlook remains precarious.

The announcement of a Greek referendum had a very important negative impact on sentiment, especially as it put the Euro-zone Summit deal in severe jeopardy. There was strong criticism from other European governments over the decision. There were fears that the EFSF would find it much more difficult to attract funds and there was little chance of Chinese investment given the prevailing uncertainty.

There were strong statements that Greece would not receive further aid until the issue of Euro membership had been resolved. The stakes were raised further by an EU threat that any decision to leave the Euro would also be a vote to leave the EU. Although the threat galvanised Greek political support, there was an increase in underlying fear surrounding the Euro-zone and Italian stresses increased, especially with the weak Italian government failing to commit over reforms.

Political tensions also remained extremely high in Greece following the announcement and prime Minister Papandreou was eventually forced to withdraw the plan after gaining a pledge of support over the austerity measures from the main opposition party.

There was an unexpected ECB interest rate decision with rates cut by 0.25% to 1.25%, the first since 2009. Incoming President Draghi justified the cut on the back of a weakening economic outlook and expectations of a mild recession by the end of 2011. In the press conference, Draghi adopted a generally orthodox stance on monetary policy. He strongly defended the bank’s current mandate and completely rejected the idea of the ECB being a lender of last resort. Italian and Spanish yields also retreated from peak levels, but Italian benchmark yields were still above 6.20% and there were continuing fears surrounding austerity measures within Italy.

There was a further strong suspicion of capital repatriation by weaker European banks which was putting underlying upward pressure on the Euro despite political and economic stresses.

Sterling

There will be further concerns over the UK economy with the latest surveys suggesting an important risk of a slide back towards recession, although there has been some evidence of resilience. Yield trends will remain extremely unfavourable for the UK currency. For now, Sterling will still have the potential to attract defensive inflows, especially with severe doubts surrounding the Euro-zone. The UK banking sector could still prove to be a source of extreme vulnerability, especially with pressure for European repatriation with high volatility likely to be a key feature.

Sterling again proved to be resilient during the week as it advanced against the Euro and found support below 1.59 against the dollar.

There was some relief surrounding the latest GDP data with a 0.5% increase for the third quarter following a 0.1% increase the previous quarter. In contrast, the PMI manufacturing index fell sharply to 47.4 for October from 50.8 the previous month which was a two-year low for the index.

The latest PMI services-sector report was weaker than expected with a decline to 51.3 for October from 52.9 the previous month. There was an underlying mood of caution within the report and inflation pressures eased, although there was also an improvement in business confidence. The NIESR also warned that there was at least a 50% chance that the economy would move back into recession as it cut growth forecasts for 2012 and confidence remained very fragile.

There were defensive capital outflows into the UK currency during the day as Euro-zone stresses continued to dominate during the day. There will still be fears surrounding the threat of capital outflows from the banking sector given pressure on European banks to raise funds.

Weekly Market analysis

The Euro-zone debt crisis has again dominated the headlines with the surge in Italian yields fuelling speculation over a break-up of the Euro-zone and fears over a global credit crunch. Ironically, capital repatriation fears could continue to support the Euro initially as will speculation over a long-term smaller and stronger Euro area. High volatility is likely to be a key feature.

Dollar

The dollar will tend to be dominated by international considerations in the short-term and there will be some defensive demand for the US currency, especially with increased Euro-zone fears. There will also be fears over a flow of funds out of emerging markets which will underpin the dollar. Underlying confidence in the US economy will remain fragile and there will be only limited fundamental support given the underlying growth vulnerabilities. There will also be fears surrounding the budget outlook, although the relative merits should see the dollar maintain a solid near-term tone.

The dollar advanced against major currencies during the week as risk appetite deteriorated again. There was also a flow of funds out of emerging markets which underpinned the US currency, although there was also still an underlying lack of conviction in the moves with Euro support on dips to below 1.35.

There was little change in the latest consumer confidence reading while regional Fed Presidents Plosser and Kocherlakota again voiced concerns over the Fed’s guidance on future policy, although there was less concern over the current policy stance.

The subsequent US economic data was slightly better than expected with jobless claims falling to 390,000 in the latest week from a revised 400,000 previously while there was a narrower than expected trade deficit of US$43.1bn for September from US$44.9bn as exports pushed to record levels. The data will maintain a slightly more hopeful tone towards the US economy.

Defensive considerations will remain extremely important and there will be dollar demand on fears over the Euro-zone and global economy. Fears surrounding emerging markets could be particularly important in supporting the dollar.

Euro

Although the Greek situation remains very serious, it has been overtaken by the developments in Italy, especially as the bond market is extremely important in global terms. There will be substantial fears over the Euro outlook and there will be strong pressure on the ECB to increase Italian bond purchases or for the German government to make moves towards fiscal union. There will be strong political opposition within Germany and there will be further market speculation over a break-up of the Euro area. There will be fears over a credit crunch which would ensure recession. Speculation over a smaller Euro area will provide important Euro support at times with volatility liable to remain extremely high.

The Euro was subjected to very heavy selling pressure on Wednesday as the situation in Italy deteriorated rapidly. There was a surge in Italian bond yields during the session as Prime Minister Berlusconi’s resignation promise failed to boost investor confidence. Benchmark yields rose through the 7.0% level, a pivotal area which helped trigger rescue packages in Greece, Portugal and Ireland.

Italy is the third largest global bond market and a huge financial commitment to stabilise conditions would be required. The EFSF is very unlikely to have sufficient resources even if it can secure additional leverage. This development will put strong pressure on the ECB to increase its bond purchases through quantitative easing.

Given these pressures, there was also increased speculation that the Euro-zone governments would be forced to consider much more radical solutions. There would either need to be a full-scale commitment to fiscal union or a move to create a narrower Euro-zone. This speculation was fuelled by media reports that Germany and France have been working on a plan for a scaled-down Euro area for months.

There was sufficient demand at the latest Italian auction even though yields increased to a 14-year high and rose sharply from the previous sale in October and this did provide some relief late in the week with the Euro recovering ground.

There was further strong rhetoric from ECB and Bundesbank officials opposing any extension of the ECB bond-buying programme. Officials, including Euro-group Head Juncker, continued to insist that there could be no expulsions from the Euro area.

The Euro-zone economic data offered no support with the Sentix investor confidence indicator weakening to a two-year low while there was a 0.7% decline in retail sales for October. There was also a 2.7% slide in German industrial production and the EU Commission cut the 2012 growth outlook sharply to 0.5% from 1.8% previously.

The Greek President announced that a new government would be sworn in on Friday under Papademos and there was a commitment to maintaining the austerity programme, although confidence was inevitably very fragile, especially after protracted delays in forming an administration.

Sterling

There will be further concerns over the UK economy as domestic conditions remain extremely difficult. There will also be fears that the Euro-zone crisis will have a negative impact on growth. There will be pressure for the Bank of England to embark on further quantitative easing which will reinforce the lack of yield support. There will still be scope for further near-term defensive inflows into the UK currency as a refuge from Euro-zone fears. The banking sector will remain important and there will be some concerns surrounding the threat of capital outflows which could also have a negative impact on Sterling.

Sterling advanced to 8-month highs beyond 0.85 against the Euro and was resilient against the dollar just below 1.60 even though it was unable to make any headway.

The latest trade data was worse than expected with a goods deficit of GBP9.8bn from a revised GBP8.6bn the previous month as exports were subdued and import demand increased. The data will increase fears over a downward revision to the third-quarter GDP data. In contrast, the NIESR estimated GDP growth of 0.5% in the three months to October, unchanged from the previous estimate which suggested that demand within the economy had not dipped very sharply at the beginning of the fourth quarter.

The Bank of England left interest rates unchanged at 0.50% following the latest policy meeting and also left quantitative easing on hold at GBP275bn. Markets will have to wait for the minutes to discover whether any members proposed additional stimulus.

There was still some evidence of defensive flows into Sterling as UK bond yields remained at extremely low levels in historic terms. There will still be concerns that banking-sector assets could be withdrawn to help underpin European balance sheets and this could expose Sterling to heavy selling pressure if market sentiment shifts.

Weekly Market analysis

The Euro-zone debt crisis will continue to dominate in the short term. There will also be increased fears surrounding the global banking sector and impact on lending as sovereign-debt fears trigger a further tightening in lending conditions which will have an important negative impact on global growth. High volatility is likely to be a key feature as governments and central banks look for an escape route.

Dollar

The latest US economic data has continued to show significant signs of improvement and fears over recession should continue to ease in the very short term which will provide some underlying support for the dollar. There will still be an underlying lack of confidence in the fundamentals and the Federal Reserve will stand ready to ease policy again if necessary. International considerations will tend to dominate in the very short term and there will be further underlying support for the US currency if there is a further tightening in global credit conditions, especially if there are major global banking stresses.

The dollar secured a net advance over the week, primarily due to the impact of defensive demand as risk appetite deteriorated with a further flow of funds into US Treasuries as fears surrounding the banking sector increased. The dollar did find it difficult to make strong headway against the Euro.

The US growth-related data was slightly stronger than expected with a headline retail sales increase of 0.5% and a core 0.6% increase for the month which maintained a slightly more encouraging outlook for spending and the economy as a whole. There was also a recovery in the New York manufacturing PMI to 0.6 from -8.5.

The NAHB housing index rose to the highest level since May 2010 at 20 while there was a bigger than expected 0.7% gain for industrial production. Jobless claims data was again better than expected with a decline to fresh 7-month lows of 388,000 from 393,000 previously, maintaining the solid tone of recent data.

The consumer inflation data was slightly weaker than expected with a headline 0.1% decline in prices, although there was still a 3.5% annual increase. Federal Reserve Governor Dudley stated that a lot of action had already been taken, but that the Fed could take additional measures if there was renewed economic deterioration.

Euro

The Euro-zone situation will remain severe in the short term with a lack of confidence triggering a further flow of funds out of the peripheral economies and the severity of the contagion threat has been illustrated by the rise in French yields relative to Germany. The banking sector will remain a very important focus in the short term and there will be the risk of a major failure as funding costs continue to increase. There will be intense pressure for a policy reversal by the ECB and German government with increased ECB bond buying. There will also be further speculation over a medium-term break-up which, ironically, could support the currency on expectations of a hard Euro area.

Initial enthusiasm triggered by the resignation of prime Minister Berlusconi evaporated quickly and there was a further intensification of Euro-zone fear during the week. There was a fresh surge in Italian yields and banking-sector pressures increased. The Euro did decline, but was still relatively resilient given the negative fundamentals with support near 1.34 against the dollar.

There were further important stresses within the financing markets as 3-month Libor rates continued to increase to the highest level since mid 2010. There was also a further increase in the dollar funding costs through the Euro swaps markets as inter-bank lending continued to decline.

The economic data was generally downbeat with a further decline in the German ZEW index while third-quarter Euro-zone GDP growth was held to 0.2% even though the German economy expanded by 0.5%.

Mario Monti was appointed Italian Prime Minister and will also take the key financial posts in the government. Underlying confidence was still extremely fragile, especially with fears over the banking sector. There was a weak Spanish bond auction which pushed yields higher while French yield spreads over German bunds also rose to fresh EMU highs above 200 basis points. Monti announced a comprehensive economic reform package, although these measures would only have a longer-term impact.

There were reports of more aggressive ECB buying of peripheral debt which put a cap on Italian yields, but there will be major doubts whether the policy is sustainable. There were also rumours that the ECB would lend funds to the IMF which would buy peripheral bonds but, if there is intense German and ECB opposition to direct funding, there will be major reservations over indirect funding as well, especially with internal ECB tensions rising.

Sterling

Confidence in the UK economic outlook is liable to deteriorate further in the short term with fears over the impact of a downturn in the Euro-zone and the threat of a renewed contraction in bank lending as funding pressures increase. There will be expectations of further Bank of England quantitative easing which will tend to weaken Sterling. Defensive considerations will also be very important and Sterling will gain important support as a refuge from the Euro area. These flows are liable to be volatile and any reversal could trigger big Sterling losses.

Sterling dipped weaker against the dollar and tested support below 1.57 before a technical recovery in volatile trading conditions. The UK currency was broadly resilient against the Euro, although there was resistance below 0.85.

The headline labour-market claimant count was better than expected with a 5,300 increase the lowest since February. The underlying data was weaker as unemployment increased to 8.3% from 8.1% while headline inflation data declined to 5.0% from 5.2% previously, although the core data was slightly higher at 3.4% from 3.3%.

In the latest inflation report, the Bank of England confirmed that it is expecting a sharp decline in inflation during 2012. In addition, there was a forecast 1.3% rate in two years time. With the bank also downgrading its growth forecasts, the implication was that there would be further quantitative easing over the next few months.

The bank continued to warn over the growth outlook and the overall tone of remarks was very downbeat with increased fears over the Euro-zone impact. Bank Governor King also voiced particularly strong concerns surrounding the banking sector with the threat of a fresh credit crunch and recession as lending contracted.

The latest headline retail sales data was stronger than expected with a 0.6% increase for the month. The evidence suggested that the figure had been boosted by retailers discounting ahead of the Christmas period with underlying fears over the outlook.

The banking sector will inevitably be an important focus in the short term, especially with an increase in financing pressures. There will be fears that the banks will cut back on lending which will further undermine growth in the economy. There will also still be fears that there will be a withdrawal of funds by the European banks which could put Sterling under heavy selling pressure.

Weekly Market analysis

The Euro-zone debt crisis will continue to dominate in the short-term, especially as it is having an increasingly negative impact on the global banking sector and the international growth outlook. There will be further intense pressure for the German government to back down and accept either Eurobonds or a change in the ECB mandate while there will also be increased speculation over a Euro break-up with high volatility a key feature.

Dollar

The latest US economic data has maintained a slightly stronger tone which has continued to ease recession fears, but doubts surrounding the sustainability of demand will continue. There will be further concerns surrounding the long-term fundamentals, especially after a failure of the congressional budget super-committee. International considerations will remain extremely important in the short-term and there will be further defensive dollar demand as global risk appetite deteriorates. There will also be the potential for capital flows out of emerging markets as dollar funding conditions tighten and these flows will continue to provide important underlying US currency support.

The dollar moves were dominated by trends in international risk appetite during the week and there was firm underlying support for the US currency as risk appetite continued to deteriorate with the dollar at a 7-week peak against major currencies.

There was a further increase in dollar Libor rates with the benchmark 3-month rising for over 100 consecutive days to just above the 0.51% level. There was evidence of further important stresses within the banking sector as liquidity continued to deteriorate with banks forced to respond to a withdrawal of funds by raising capital.

Congressional sources confirmed the high probability that the Super Committee looking at long-term budget options would fail to reach agreement this week. This initially undermined risk appetite, but there was some relief following an announcement from the major rating agencies that there would be no immediate impact on US credit ratings.

The US third-quarter GDP revision was weaker than expected with a decline to 2.0% from the 2.5% original estimate and this had a further negative impact on risk appetite as confidence in the global economy deteriorated again. The US jobless claims data was close to expectations with a figure of 393,000 in the latest week from 388,000.

Euro

The Euro-zone situation will remain extremely serious with a flow of funds out of peripheral economies and there will also be a growing risk of net capital flows out of the area. Even if the ECB maintains its opposition to increased peripheral bond buying and quantitative easing, there will be strong pressure for a further cut in interest rates. There will be near-term capital repatriation by the banking sector to strengthen balance sheets which will provide some degree of Euro support, although this could prove to be increasingly fragile. There will be further speculation over a Euro break-up if Germany maintains a hard-line stance which could ironically underpin the Euro on hopes of a hard currency.

The Euro was able to resist heavy selling pressure, but there were net losses for the week and a sense that the Euro-zone crisis had reached an even more dangerous stage which increasingly undermined confidence in Euro assets.

There were media reports that a plan to increase ECB lending to the IMF which would then allow the IMF to buy peripheral bonds was gaining traction. This speculation, in turn, increased optimism that there would be relief for peripheral but the mood of hope faded very quickly as fears over a Euro-area breakup continued to increase.

There was a much weaker than expected German bond auction with the Bundesbank forced to bid for its own paper as investor demand was extremely weak. The failed auction increased market fears that the contagion effect was spreading to Germany as underlying confidence continued to deteriorate. There was a strong market reaction to the auction as investors feared a wider exit from Euro-zone bonds.

There was also a warning from the Greek central bank that Greece was facing its last chance for staying in the Euro-zone and that there was a growing threat that social cohesion would breakdown. There was a report from ratings Agency Fitch that France’s credit rating could be under threat if there were further shocks to the economy. There was a sharp decline in Euro-zone industrial orders and the PMI flash manufacturing index weakened to a two-year low.

Equity markets were unable to gain support as underlying confidence continued to deteriorate with peripheral bond yields rising again and there was also a further sharp rise in Belgian yields as Dexia was forced to tap emergency funding. There was a further increase in fear surrounding the banking sector as a whole amid speculation over a further tightening in liquidity as banks remained shut-out of wholesale markets.

Portugal’s credit rating was cut again by Fitch while the Troika would return to Greece on December 12th for negotiations surrounding the next loan tranche and second rescue package. Peripheral bond yields continued to rise during the week.

The main focus was on the issue of Eurobonds at a meeting between German Chancellor Merkel, French President Sarkozy and Italian Prime Minister Monti. Merkel again voiced strong opposition stating that they would give the wrong signal to the markets. The hard-line rhetoric increased fears surrounding the Euro-zone which intensified the deterioration in international risk appetite.

Sterling

Confidence in the UK economic outlook is liable to deteriorate further in the short-term with fears over the impact of a downturn in the Euro-zone and the threat of a renewed contraction in bank lending. There will be expectations of further Bank of England quantitative easing, although the bank has suggested that it will wait until the current programme is completed before any further action. There will be defensive capital inflows, although it may become increasingly difficult to sustain inflows at current yields. The UK currency will also tend to weaken when risk appetite deteriorates.

Sterling weakened against the dollar and also found it difficult to make any headway against the Euro during the week even though there were defensive capital inflows as a refuge from the Euro-zone. Sterling was also unsettled by a further deterioration in risk appetite and dipped to lows near 1.5450 against the dollar.

The Bank of England minutes from November recorded 9-0 votes for both the interest rate decision and the amount of bond purchases. There was certainly a downbeat assessment of UK growth prospects with weak lending causing concerns. The minutes also stated that there was little merit in fine tuning the amount of quantitative easing, especially as it would take three months to complete the existing purchases.

The comments suggested that there would be no further action until at least February which provided some degree of relief to the UK currency. There were also reports that Japanese funds were switching into UK gilts from Euro-zone bonds which underpinned the currency as a European safe-haven.

The revised third-quarter GDP growth estimate was steady at 0.5%, but the figure relied more on a build-up of inventories which increased fears that there would be weaker data for the fourth quarter. The latest CBI industrial survey was also weak with a figure of -19 from -18 previously as export orders declined sharply.

Weekly Market analysis

The Euro-zone debt crisis will continue to dominate in the short-term, especially with a key summit meeting at the end of next week. The key European leaders do have a strategy for moving forward with the possibility of increased support for peripheral economies conditional on a commitment to tougher fiscal discipline. There will still be major political barriers to any deal and major doubts whether it will be sufficient to ease market pressures with high volatility likely to be the key feature.

Dollar

The latest US economic data has maintained a more confident tone and increased hopes that the economy can resist a fresh downturn. The situation will remain fragile and there will certainly be fears that Euro-zone turbulence could have a serious negative impact. There will also be a high degree of unease surrounding the budget situation. The Federal Reserve will keep interest rates extremely low and will also consider further action if required which will curb dollar support. Defensive considerations will remain extremely important and any reduction in fear surrounding the Euro-zone and global liquidity would lessen dollar demand. Nevertheless, underlying support is likely to remain solid for now.

The dollar maintained a firm tone initially, but demand weakened following the central bank move to boost dollar liquidity.

Risk appetite was boosted initially by the Chinese central bank decision to cut reserve ratio requirements with the move intensifying sharply following co-ordinated action by the global central banks. The Federal Reserve and other central banks announced that they would cut the cost of dollar swap rates and increase liquidity in the market. The net impact of this will be to make dollar borrowing less costly and make it easier for banks to access funding, lessening the threat of a major banking-sector collapse.

The US economic data was again better than expected with an ADP private-sector employment increase of 206,000 for November from a revised 130,000 while the Chicago PMI index rose to 62.6 from 58.4 and pending home sales rose strongly. The data increased optimism that there would be a solid employment report on Friday.

The PMI manufacturing data was also stronger than expected with an increase to 52.7 for November from 50.8 previously and there was a significant recovery in both the orders and prices components which continued to suggest that the economy is making some headway. The dollar impact will again be mixed as potential yield support would be offset by reduced defensive demand for the US currency.

Regional Fed President Bullard hinted that there would be no major policy moves at the December FOMC meeting, although there was increased speculation that there would be a technical cut in the discount rate. Fitch maintained its AAA rating for the US, while lowering the outlook to negative from stable, reminding markets over the very fragile US deficit situation.

Euro

The Euro-zone situation will remain extremely serious with recession fears also acting to intensify fears surrounding sovereign debt issues. Measures to boost liquidity will have some positive impact, but there will still be a high degree of fear surrounding solvency. There will be strong pressure for the ECB to cut interest rates again and take a more aggressive stance in buying peripheral bonds. Further action may be possible, but the ECB and German government will demand very strong assurances on budget policies and there will certainly be major fears that action will be insufficient to prevent a Euro break-up.

The Euro retreated back to the 1.33 area during the New York session on Tuesday before recovering as risk appetite was boosted and sentiment improved slightly.

In its latest money-market operations, the ECB failed to attract sufficient bids and the latest SMP bond purchases were, therefore, not fully covered. The move increased speculation that the ECB would effectively have to move to quantitative easing. There were also further expectations of a cut in ECB interest rates.

Euro-zone Ministers agreed that the first 25-30% of new bond issues would be insured as part of their efforts to leverage the fund, although there was a widespread recognition that the EUR1trn target would be out of reach. There were also suggestion of talks with the IMF which could lead to additional support for peripheral economies.

There was a flurry of political rhetoric ahead of next week’s EU Summit as French President Sarkozy in particular warned over the efforts required to prevent a break-up of the Euro area with a call for Treaty changes. There was a clear warning from political and banking figures that the moves to boost liquidity will help ease immediate tensions, but that there are still severe structural difficulties.

The underlying plan still appears to be that major leaders will seek political concessions from the Euro-zone countries which would push them much closer to rapid fiscal integration. In return, there will be increased support for peripheral economies. The ECB also suggested that if there was a move to guarantee fiscal rules then the ECB would consider providing additional support. Tensions will inevitably increase ahead of next week’s summit given fears that failure or an inadequate response would trigger a terminal escalation of the crisis.

Sterling

Confidence in the UK economic outlook is liable to deteriorate further with fears over the impact of a downturn in the Euro-zone. The fiscal outlook has weakened further and there will be severe debt implications if there is a move back into recession. There will also be speculation over additional Bank of England quantitative easing once the current round of bond purchases is completed in February. There could be further near-term defensive Sterling demand as an alternative to Euro-zone assets, although these flows would be in severe jeopardy in the event of a credit-rating downgrade.

Sterling was subjected to choppy trading conditions during the week and Euro/dollar moves tended to dominate as the UK currency made some headway against the dollar with a temporary move above 1.57, but failed to sustain an advance against the Euro.

In its Autumn Budget Statement, the government was forced to admit that the economic outlook was significantly worse than expected. The OBR stated that GDP growth was likely to be 0.9% this year following by 0.7% next year and this will inevitably put upward pressure on the budget deficit with borrowing set to be at least GBP100bn higher than expected over the next five years.

The immediate market impact was measured as the adjustments were broadly in with expectations. There was, however, a statement from ratings agency Fitch that the revised UK projections involved a significant deterioration and there was a clear warning that the credit rating could come under pressure. A downgrading would pose very substantial risks to UK confidence and Sterling.

The UK economic data was weaker than expected as the CBI retail sales survey weakened to the lowest level since the first quarter of 2009 at -19 for November from -11 previously. The PMI manufacturing index dipped to the lowest level since July 2009 at 47.6 from a revised 47.8 previously. There was a further downturn in orders and the rate of decline in employment was also the highest for over two years.

Following the latest Financial Stability Review, Bank of England Governor King again warned over the risk of a renewed credit crunch in the economy and also warned in uncompromising terms over the dangers posed by the Euro-zone crisis.

Weekly Market analysis

The Euro-zone debt crisis will continue to dominate in the short-term and there will be a high degree of uncertainty over whether there has been sufficient progress at this week’s Summit to stem selling underlying pressure. If the Summit is deemed to have failed, then there will be the risk of severe tensions in Euro-zone markets and a wider deterioration in risk global appetite which would provide important defensive dollar support.

Dollar

The US economic data will maintain a slightly more optimistic tone towards the short-term outlook, especially with solid gains in the labour market. There will still be a very cautious tone, especially with some budget support measures due to expire at the end of the year. The Federal Reserve will also maintain a highly-expansionary monetary policy and is likely to indicate that there will be scope for further monetary support measures if required. International considerations will remain extremely important for the US currency and there will be demand for the dollar when risk appetite deteriorates sharply.

Following a slightly better than expected employment report at the end of last week, attention was focussed firmly on the Euro-zone and dollar trends were driven to a large extent by developments in risk appetite. After weakness during the middle of the week, the US currency was able to regain some significant traction as confidence faltered again as it gained against European and commodity currencies.

The US ISM services-sector index was weaker than expected with a decline to 52.0 for November from 52.9 previously. Orders gained slightly for the month, but there was an unexpected retreat in the employment index back to below the 50 level. The data overall served to dampen optimism surrounding the US economy.

In contrast, there was a drop in jobless claims to 381,000 in the latest week from 402,000 previously and this provided a brief boost to risk appetite with markets also looking ahead to next week’s Federal Reserve interest rate decision.

Euro

The Euro-zone situation will continue to be monitored very closely in the short-term amid serious fears that there could still be an underlying break-up in the currency area. There will also be fears surrounding the banking sector as funding difficulties continue. Although the ECB has cut interest rates and boosted liquidity, there will be pressure for more aggressive action to provide support. The EU Summit will be extremely important for sentiment and there may be some initial relief, but there will still be an important underlying lack of confidence in the outlook.

The Euro gained support at times, but it was unable to sustain gains and tested support below 1.33 against the dollar. Following Standard & Poor’s warning over European credit ratings, there was also a warning that the AAA EFSF rating could be at risk if there were any downgrades to ratings for individual Euro-zone countries.

There were further tensions within the banking sector as funding remained extremely tight. Central banks held their first liquidity auctions since last week’s announcement of lower swap rates and the lower rate triggered a big increase in demand for dollars with over US$50bn in funds for the three-month tender. With Libor rates increasing to 0.54%, the cost of securing liquidity from central banks was only slightly higher than from the market. There were also warnings from the German government that it could force recapitalisation on the banks.

The ECB outcome was in line with consensus expectations as the central bank cut the main financing rate to 1.00% from 1.25%, matching record lows, although the vote was not unanimous with some members preferring to wait.

There was a reduction in GDP growth forecasts by the ECB and there was general pessimism surrounding the outlook. The central bank announced that it would introduce new three-year repo operations to provide long-term liquidity to the banking sector. There was also a relaxation in collateral to allow a wider range of securities.

There were very important comments surrounding bond purchases with Draghi maintaining the orthodox line that it was not the ECB’s role to provide monetary financing for government deficits. These comments seriously dampened market expectations that the ECB would be willing to provide increased support and the Euro dropped sharply following the report as Italian yields spiked higher. It remains to be seen whether there will be a change in tone following the Summit.

As EU Leaders gathered for the Summit meeting, there were further tensions surrounding the introduction of majority voting for the ESM which is due to replace the EFSF in 2012. A draft agreement indicated that any Treaty changes would be limited to the 17 Euro-zone states rather than the 27 EU members. There was also an agreement that the ESM should not be given a banking licence while bailout decisions would be taken on a 85% majority.

Sterling

Confidence in the UK economic outlook is liable to deteriorate further with fears over another recession, especially given the Euro-zone downturn. The budget outlook has weakened further and there will be severe debt implications if there is a further downturn in the economy. There will also be speculation over additional Bank of England quantitative easing once the current round of bond purchases is completed in February. There could be further near-term defensive Sterling demand as an alternative to Euro-zone assets, although these flows could suddenly reverse if doubts escalate and there are increased credit-rating fears.

Sterling was little changed for the week as a whole as it failed to hold gains against the dollar and tested the 1.56 area, but it did strengthen to one-month highs against the Euro. There was some initial relief following the latest PMI services-sector report with the index edging high to 52.1 for November from 51.3 previously.

The Bank of England announced a new precautionary liquidity operation which would be used in the event of credit conditions deteriorating further, although the bank was keen to emphasis that there were no liquidity difficulties at present.

There was no surprise from the Bank of England on Thursday as interest rates were left on hold at 0.50% while the quantitative easing amount was also unchanged at GBP275bn. As usual when there is no policy change, there was no MPC statement.

There will be speculation of political isolation surrounding the EU Summit and, much more damagingly, there will be fears that the UK economy will be damaged severely by any Euro-zone break-up. Safe-haven demand for Sterling will continue to be a key component and there will be expectations of further defensive inflows despite fears over the UK outlook. The principal feature is likely to be high volatility.