Although the political crisis in Egypt is still unresolved and 1 million people are expected to take to the streets today to protests at President Mubarak's refusal to cede control of power, the markets continue to trim risk aversion trades. But although markets have settled down, the shift back into riskier assets has been tentative and sentiment could turn sour if tensions escalate. For now though, the main driver of the markets during the European session has been economic data.

Asset prices have been buoyed by positive economic news including a 16-year high in UK manufacturing PMI, which rose to 62, smashing expectations of 58. This was further evidence that the manufacturing sector is driving the UK economy, and in the aftermath of this release GBPUSD punched through 1.6100 and it is currently hovering around this level. The pound shrugged off weak mortgage approvals and money growth, and if it can sustain these gains then it leaves the 1.6270 highs from the start of November as the next level to beat.

The dollar is weak across the board today as traders continue to reverse their positions after flocking to the greenback's safe haven status on Friday. The dollar index has fallen by 0.5 per cent since the start of the European session. The dive lower in the buck has also hit USDJPY. This cross is currently trading at 81.55/60 - the lowest level for a month. We may see the pair drop to 81.10 before it finds some good support. But at these levels, one has to bear in mind the risk of intervention by the Bank of Japan to forcefully weaken the yen. So far, Japanese officials have not spoken out about the strength in the currency, but it remains a risk. One thing that might ease the authorities' concerns is that although a strong yen is negative for exports, news that wages fell for the first time in 10-months in December may actually help boost profit margins as labour costs fall, which may go some way to negating the impact of a strong yen.

Elsewhere, the Aussie dollar has had a strong run since the announcement that the Reserve Bank of Australia kept rates on hold earlier today. The Bank was less dovish than some may have expected, saying that it would look through the temporary impact on growth and prices of the flooding in Queensland last month. The Bank also gave a more upbeat assessment of its view on global growth compared to its December statement. Thus, the RBA seems to be sticking to its hawkish bias as the underlying fundamentals of the Australian economy remain strong.

There was also some good news on the economic front for Europe. The overall unemployment rate fell to 10 per cent in December from 10.1 per cent in November. This was boosted by an improvement in Germany, where the unemployment rate is at its lowest level since 1992. While Germany continues to be the main engine of growth in the Eurozone, there was some encouraging news from the periphery. Unemployment actually fell in Ireland and remained steady in the other indebted nations at the end of last year.

Stocks continue to move higher along with commodities. Brent crude oil is above $100 a barrel on concerns in the Middle East, particularly concerns about the Suez Canal, which is a major thoroughfare for commodities to get to Europe and the rest of the world. Until Egypt's political situation is resolved, we think that commodities will remain well bid. The Thomson Reuters/ Jeffries commodity index has broken higher and is now at its highest level in more than 2 years.

Later today US construction data and the ISM manufacturing index are released. If they are strong then we may see the greenback reverse some of its recent weakness.

Data watch:
US 15:00 GMT (1000ET) ISM Manufacturing (Jan) index 58 EXP, 57 LAST
US 1500 GMT(1000 ET) Construction spending MoM (Dec) 0.1% exp, 0.4% last.
Euro Area 16:30 GMT (1130 ET) ECB's Nowotny Speaks
Switzerland 16:30 GMT (1130 ET) SNB's Jordan Speaks

Best Regards,
Kathleen Brooks| Research Director UK EMEA |
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