Renewed worries on the German banking front are keeping European stocks in the red and lending further support to the Japanese currency on reduced risk appetite. Germany’s IKB drops 20% on worries that will announce further write-downs of as much as 2 billion euros according to Reuters. Euro shrugs the news for now, regaining the 1.4550s but we warn of renewed selling tomorrow at the crucial release of the ZEW sentiment survey, which will reflect responses in the aftermath of the Societe General losses. US retail sales on Wednesday and Fed Chairman Bernanke’s testimony on Thursday will maintain the bias in favor of the Japanese currency as risk appetite remains on the defensive.

Euro Capped at 1.4580 Ahead of Tuesday’s ZEW

Euro extended its rebound past the 1.4550 mark after ECB’s Weber reiterates the central bank’s willingness to do anything to counter inflation and that inflation remains a cause of concern. It is expected that Weber and other ECB members will reaffirm their inflation hawkishness after JC Trcihet accentuated the downside risks to the economy in Thursday’s press conference.

We expect EURUSD to remain capped at 1.46 ahead of tomorrow’s release of the closely watched ZEW investment survey (5.00 am EST) is expected to show further deepening pessimism by German financial market participants. The business sentiment index is expected to have dropped to -43.5 in Feb from -41.6 in Jan while the current situation index is seen at 50 from 56.6. Unlike the IFO, the ZEW survey focuses on financial market participants, who are likely to give more negative responses given the deterioration in the markets and accumulated banking and hedge fund losses. Thus, while there is the possibility of seeing the euro crop up to as high as $1.4590s, the ZEW could potentially drag the pair back to 1.45 and to as low as 1.4460. There will be no US data released on Tuesday, which may accelerate losses towards 1.4440.

Yen Gains on Further Global Writedowns

After having been sold off across the board late last week, yen makes broad gains in midmorning European trade on evidence of further struggle by European banks. With European stocks joining their Asian counterpart in the red, and news of Yahoo rejecting Microsoft’ offer will likely dampen US equities. All eyes will be on the S&P and whether it will hold above the 1,300. Wednesday’s release of the US retail sales will be key in determining risk appetite and dollar sentiment as markets anticipate a rebound from -0.4% in Dec to 0% in Jan.

Support seen holding at 106.50, backed by 106.20, while upside capped at 107.20. Key resistance stands at 107.50. We warned last week that 107.80 acted as a key resistance seen for the past 3 weeks and was expected to do so as long as downside continues to act on US equities and risk appetite. We stick with this call.

Weak Data More Risky for Sterling than Inflation

We deem today’s release of stronger than expected UK PPI figures numbers as the latest pretext to draw the bears onto the British pound, which has proven increasingly susceptible to weak economic data than to high inflation numbers. UK factory prices rose 5.7% y/y in Jan, the highest since 1991, well above the 5.1% consensus forecast. Lingering evidence of inflation is seen more as a way to prevent 50-bp rate cuts than to delay easing altogether. The latest round of weak data emerged from the following: The Dec trade deficit widened to -£4.72 billion from -£4.4 billion. Separately, the British Chamber of Commerce forecasts 2008 GDP growth forecasts at 1.7% from 3.1% in 2007. Q4 Business Confidence Monitor fell to a 5-year low of -7.2 from -3.9. Last week, the National Institute of Economic and Social Research estimated a 0.5% rise in GDP growth for the three months through January, the lowest pace since 2005. That followed 0.6% in Q4.

Sterling watchers await Wednesday’s the Bank of England’s quarterly inflation report, which will shed further light on the Bank’s 2-year take on inflation considering the current slowdown. Recall the November report hinted at rate cuts to start in early Q1, but the central bank ended up easing in December. We would expect sterling to maintain its weak bias even in the event that the report deems inflationary pressures to remain on the upside at the end of the 2-year period.

Cable is seen facing trend line resistance at 1.9560, while bias remains negative slanted. Support starts at 1.9460, backed by 1.9430.

Loonie Cautiously Steady

Friday’s stronger than expected Canadian jobs figures (unemployment rate fell to 5.8% from 5.9% and payrolls +46K from -19K) continue to maintain USDCAD below parity. But according to CEP News, new Bank of Canada Governor’s comments at the G7 hint at further easing, when he said I’m comfortable with the statement that additional monetary stimulus will be required in the near team adding that The timing and degree of that stimulus will be determined at future fixed announcement dates. While the statements signaled the BoC may not resort to cutting rates by half point moves, the outlook remains for at least one quarter point move next month. The BoC cut rates by 25 bps in both its Dec and Jan meetings, lowering rates to 4.00% to bring them at their highest level since May 2004 against their US counterparts.

CAD watchers await the 8.30 am release of the Dec new housing price index seen up 0.3% from 0.5% and Thursday’s release of the Dec trade figures expected at CAD 3.6 bln from CAD 3.7 bln.

We expect USDCAD to retest the 0.9970s until encountering support at 0.9940. But renewed losses in Wall Street may be seen lending support to the pair with resistance standing at 1.0020.