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It's a quiet week in the City as most people take advantage of the bank holidays to extend their Christmas breaks, however the Eurozone debt crisis never takes a break. As we enter the third consecutive year where European debt concerns have dominated market sentiment the effects of the crisis continue to rock markets.

After a fairly range-bound day the euro took another dip below 1.30 versus the dollar this afternoon  as the ECB announced that its balance sheet rose to a record EUR 2.73 trillion, as lending to banks jumped from EUR 214BN to EUR 879BN in just one week. Now most of this surge in lending was down to the LTRO - the long-term refinancing operation started the week before Christmas. Banks hoovered up the EUR 489BN on offer suggesting that banks are in worse shape than first thought.

However, the question as we enter 2012 is what do the banks do with all of this cheap money? There were hopes that it would be used to purchase sovereign debt to ease funding concerns for next year. Indeed at a debt auction in Rome today, demand for Italian 6 and 24-month debt was particularly strong and yields fell sharply compared to an auction last month. The 6-month yield fell to 3.25%, down from 6.5% last month, while 24-month debt fell to 4.85% from 7.8% 4-weeks ago. Added to this demand was strong.

10-year Italian bond yields dropped from a high of 7% to 6.75% after the auction, however, since lunchtime in Europe yields have been on the rise again, as if to remind us that all is not well in Europe and not to take our eyes off the ball. Italy has plenty of hurdles to clamber over, including an important one tomorrow morning. Rome is scheduled to sell EUR 8.5bn of 2014, 2018, 2021 and 202 bonds, which will be a much harder sell than the short-term debt it shifted with ease this morning.

Added to this, it's too early to tell if the ECB's latest policy tool designed to ease sovereign fears has worked. We learned last night that European banks had deposited a record EUR 400bn with the ECB over the festive period - they would rather deposit funds in the safety of the central bank where yields are next to nothing, than lend to their peers, suggesting there remains real default fears out there as we head into 2012. If they won't lend to other banks then why would they lend to governments that are the major source of concern for some of the banks?

As I write, stocks have reversed earlier gains in Europe and the US, while Italian and Spanish yields are higher while safe haven markets like Germany, the UK and the US have seen yields fall. Likewise, the dollar is sharply higher across the board and EURUSD is hovering around 1.2980. The major move has been in EURJPY which is testing the all-time low of 100.97 - reached in October. In times of uncertainty the safety of the fairly static yen is attractive to investors, so we could see EURJPY break new ground if fears continue to snow ball before the end of the year.

The shift in risk sentiment has dragged AUDUSD lower below 1.0160. There were some rumours that a large Swiss bank sold off a large clip of euro, triggering 1.30 stops in EURUSD. However, in thin markets when liquidity is weak, these moves can get magnified. The next support is 1.2950 then towards 1.2870 - the 100% retracement from the 1.4940 high back in May. The S&P is finding support at 1,258 - the 100-day sma, the next support lies at 1,235.

It may not be a quiet slide into year-end after all.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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