The week has started on a defensive note. Friday's rate hike from the Bank of India has furthered speculation that other Asian central banks, including the PBOC, could be on the point of following suit. This talk has been sufficient to weaken 'risky' assets. Stocks are mostly lower in Asia and in Europe today, oil has dived back below the $80 /b which has undermined both the AUD and the CAD. Adding to the pressure on the AUD have been comments from the Australian Business Group that the economy will not return to trend growth until well into 2011. This will strengthen the view that the RBA will retain a steady hand on policy over the next few months. On the charts USD/CAD managed a reversal day on Friday which suggests that a move back to parity will be a choppy one.

Increasing the negative sentiment in the market were weekend comments from the IMF's Lipsky that advanced economics face acute challenges in tackling high public debt and unwinding existing stimulus measures. He also commented that all G7 economies bar Canada and Germany will have debt/GDP ratios close to or above 100% of GDP by 2014. These warnings underpin the likelihood of below trend growth in major parts of the industrial world over this year and 2011 as budget austerity is addressed. It also begs a discussion as to how close to a credit rating downgrade the UK is. While credit rating companies have flagged this as a possibility, government officials have not acknowledged this as a true risk. The March 24 budget could be decisive in the future decisions of the credit rating companies. The Labour government has indicated that sweeping spending cuts will be announced this week. This should be sterling supportive. However, it will take an extended period of austerity to significantly improve the UK's dire fiscal position and this is likely to leave cable vulnerable and potentially volatile for some time yet. Cable this morning has been able to retrace most of its overnight losses, though it is struggling to regain the USD1.500 level. Weekend political opinion polls continue to hint at the prospects of a hung parliament after the general election.

Strong buying interest at the European open lifted EUR/USD to an intraday high of USD1.3544. EUR buying ran out of steam however amid the ongoing uncertainty about how the Greek government will fund its deficit this year. Germany continues to dig in its heels on the issue of support for Greece and while the door to the IMF is open suggesting that a Greek debt default is not likely, the difficulties the EU has in finding a solution for Greece highlights the inadequacies of EMU. Until the EU agrees a procedure for dealing with fiscally errant members and simultaneously puts in place adequate fiscal controls, it will continue to draw speculation as to whether EMU is a workable system in its present form.

EUR/CHF has been squeezed higher following a reiteration of warnings from the SNB that it would act decisively to prevent an excessive appreciation of the CHF vs the EUR. In its Quarterly Bulletin, the SNB stated that expectations for the Swiss recovery in the coming 6 months are cautiously optimistic.

There is no key data scheduled this afternoon. The ECB's Trichet and the Fed's Lockhart (FOMC non-voter) are due to speak. The BoJ's minutes of the Feb meeting will be published tonight.

Jane Foley
Research Director