Today's session saw Spanish yields up, as the markets continue to fret about whether the government will be able to meet its fiscal targets as well as the implications of austerity measures on the potential for growth. The government unveiled €27 billion in deficit reduction in its budget but the markets continue to be concerned that not only to the country perhaps not cut enough but that the austerity measures and announced will way on the economy and create a negative feedback loop which amid a difficult for country to pay back its debts.

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It's a bit of a lose-lose situation for Spain as explained by the Spanish Finance Minister.

From MarketWatch: Spain Finance Minister Luis de Guindos told The Wall Street Journal in an interview published Tuesday that there was no margin for error, in the 2012 budget the government released last week. If you don't make enough adjustments, markets will penalize you. But if you go too far, markets could also penalize you, he said, referring to concerns over economic growth... Another concern for investors is that Spain's regional governments, responsible for a chunk of its budget overrun last year, won't toe the line over budgets.

Italy Might Need to Tighter Screws Further As Well

Turning to Italy, the concern is that the technocratic government of Mario Monti may have to impose further austerity measures if the economic downturn is sharper than expected or if the tax measures to shave the deficit do not come to fruition. Or, as the markets concern is now that the latter leads to the former.

A report from the last Euro-zone finance minister meeting looked at these dangers.

From Financial Times: But it added: Italy's efforts to meet the headline budgetary targets may be hampered by the depressed growth outlook and relatively high interest rates. The government should stand ready to avoid any slippage in budgetary execution and take further action if needed.

width=307Economists are warning that tax increases - on income, property and goods - are strangling already weak consumption levels and that a spiral of recession and greater austerity would drive Italy's budget targets even further beyond reach.

Mr Monti has repeatedly ruled out any further austerity measures following a €30bn euro package passed in December.

From Wall Street Journal: Prospects are dim. Consumers have insurmountable obstacles ahead of them, with higher income tax rates from March, higher property taxes as of June and a value-added tax hike in September, said Unrae President Jacques Bousquet.

Date from Italy showed unemployment rising to 9.3% in March, the manufacturing PMI remaining mired in contractionary territory (at 47.9 in Mar vs 47.8 in Feb), and new car sales (registrations) falling 27% in March a sign that consumers are postponing big purchases.

Impact on EUR - Could it Underperform in Q2?

The key question then is will this concern around Spain and Italy - which we have been following over the last couple of weeks - becomes a problem for the EUR, and causes a new round of weakness for the common currency.

Yesterday we looked at the EUR/CAD, as one currency pair that we could play euro weakness against the strength of the US economic momentum using the Canadian dollar as a proxy.

Another possibility could be the EUR/GBP pair as the UK economy put in some better-than-expected readings from both its manufacturing and construction PMI's, and we awaits tomorrow's services PMI to see if the UK economy is perhaps growing at a slightly faster pace than anticipated coming into those reports.

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The EUR (above seen in the Bloomberg correlation-weighted currency index) has been supported by the action of the ECB the past 3 months, but attention is now shifting from the easing of the tail risk of a banking crisis, to austerity and growth outlooks.

The ECB interest-rate decision tomorrow will be important for the tone that President Draghi sets in regards to possibility of any further easing measures. if you close a more harder line, that could undermine in the expectation that the ECB is considering during further stimulus. There is division among the ECB, and with heightened inflation expectations because of rising oil prices the ECB will find itself limited in its scope to act to help growth. At the same time if ECB takes a weaker outlook for growth prospects it would increase the chances that the markets would increase speculation that if not an injection of bank loans, the ECB might cut interest rates in the middle of the year - a fundamental factor that should also weight on the EUR.

We'll have to see how this story progresses as it's a bit early to call an end to the recent EUR strength, but if yields continue to rise in Spain and Italy, and we continue to see economic data showing that austerity measures are creating deeper recessions than anticipated coming into the year the EUR could underperform in the 2nd quarter.

We'll follow up with this important theme as well as other currency, equities, bonds, and commodities markets all week long in our Market Intelligence Briefings.

Nick Nasad is a macro economist, market analyst, and educator; and one of the main contributors to FXTimes.com - provider of Forex News, Analysis, Education, Videos, Charts, and other trading resources.

Information and opinions contained in this report are for educational purposes only and do not constitute an investment advice. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness. FXTimes will not accept liability for any loss of profit or damage which may arise directly, indirectly or consequently from use of or reliance on the trading set-ups or any accompanying chart analysis.