There has been so much negative comment about the fiscal position of Greece in the past few months that it would be an exaggeration to say that last night's downgrade of Greek debt to junk status by Moody's was a complete surprise.  That said the news serves as a reminder that fears of a Greek default still exist and also of the depth of problems that still face the Eurozone.  Consequently it took the wind out of the sails of the risk trade, though appetite for risk is still in evidence this morning.  Having performed well in recent sessions, stocks are trading mixed to higher, the JPY has given up some of its earlier strength and the AUD,NZD and the CAD have returned to better levels.  The weak German ZEW survey had only a short-lived negative impact on the market.  

Unsurprisingly Greek-Bund spread have widened significantly this morning in the wake of the Moody's news.  Irish, Spanish and Portuguese bond spreads have also be dragged to wider levels.  The results of the Spanish bill auction, however, will have tempered some of the negative sentiment.  The 18 month tender mustered a solid bid/ cover ratio of 3.51, the bid/cover on the 12 mth tender was 1.49.  The ability of the Spanish government to raise funds on the open market is clearly a relief to both Spanish and EU policy makers.  However, Spanish debt would be far less attractive if it were not for the existence of the EU's monetary fund.  Spain has a lot way to go before its deficit is cut down to an acceptable size and market confidence fully returns; and there are likely to be many pitfalls along the way.  Slow growth and 20% unemployment levels will make deep austerity measures particularly difficult to stomach.  The outlook for growth is all the worst for the lack of international credit on offer to Spanish corporates.    Fears of further causalities in the Spanish banking sector are also widespread.   All this suggests that aggressive long EUR positions are not for the feint hearted.

Sterling was hit hard on the release of weaker than expected UK May CPI data.  This came in at 3.4% y/y, down from 3.7% in April and subdued fears that BoE rates could be forced higher by the end of the year.  That said, inflation is still well above the BoE's 2.0% target rate and the debate about how much inflation potential exists in the UK economy is unlikely to fade fast.  The BoE expects that excess capacity will bear down on inflation.  However, inflation hawks argue that a great amount of excess capacity has been destroyed by the recession.  Sterling is likely to remain sensitive to the inflation argument.  Cable has recovered from this morning's sell-off, pushing back towards USD1.4780.  Its ability to remain above the 21 day sma suggests it remains in a corrective uptrend on the daily chart.  Stronger RICS house price data will also have lend some support to the pound this morning.  

The BoJ announced this morning that it will offer as much as Y18 trn in loans to companies for a long at 4yr in an effort to promote growth.  The measures are part of a plan by the BoJ to target 18 growth areas.  The size of the loans, however are not deemed to be great enough to make a huge impact on the economic outlook.  That said, given the pledge by new PM Kan that there should be a cap on new bond sales, pressure will remain on the BoJ to stimulate growth.  PM Kan is expected to announce a new fiscal and growth plan later this month.  

The minutes of the June RBA meeting have hinted that the board has entered a wait and see mode.  AUD/USD fell below 0.8520 in early London hours before recovering towards last night's closing levels.  

Canadian manufacturing and productivity data are due this afternoon.  US import price, Empire manufacturing, Tic data and NAHB housing numbers are also due.  

Jane FoleyResearch DirectorFOREX.comjfoley@forex.com+44 207 398 5024

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