The strength of the Chinese stock market overnight brought a temporary reprieve for risk appetite overnight.  On the whole the JPY crosses started the European morning on the soft side as some of last week's tensions relaxed on the assumption that the Chinese authorities would slow the pace of monetary tightening.   However, news that the Bank of Spain has been forced to step to support savings bank Cajasur after a failed merger with Unicaja has ensured that underlying tensions remain in the Eurozone.  Cajasur is a small bank and the Spanish government has been quick to respond with reassurances that the Spanish financial system is absolutely solvent.  However, following last week's news concerning the lifting of mark to market rules on debt on the books of Italian banks the market is becoming concerned that more bad news concerning the positions of banks could be in the pipeline.  Afterall, the EU/IMF's EUR750 bln European Support Plan is designed to protect the financial institutions holding the debt of Greece et al in addition to supporting the government of Greece. EUR/USD has dropped back to USD1.2410 in European hours, the FTSE 100 coincidentally given up most of its opening gains and the JPY also taking back its overnight losses on the crosses.  

Fiscal policy is certain to remain centre stage this week. Warnings regarding a possible general strike in Spain in response to the government's tough position on austerity are a reminder of how much fiscal coherence has been lost in EMU.  The Spanish government has little choice but to plough ahead with reform but strikes will serve to widen fears that budget reform conducted under the strait jackets of slow growth and an inflexible exchange rate could be too much to bear.  Speculation that EMU may be blown apart by this crisis may be muted but it has grown.  Medium-term EUR/USD is still biased lower towards USD1.18 on a 1 to 3 mth view and potentially below.  

The UK government has announced GBP 6.25 bln in spending cuts, slightly larger than the GBP 6 bln touted in the Tory election manifesto.  The government's business department and devolved administrations will feel the weight of these savings, though these are just the tip of the iceberg.  The government is expected to start swinging the cosh on the GBP 163 bln budget deficit at the June 22 budget.  Sterling has reacted well to Chancellor Osbourne's tough words on the deficit; EUR/GBP has pressed down towards 0.8586.  However, unions are less pleased.  The degree to which the electorate accepts austerity will play a crucial part in any sterling recovery vs the EUR medium-term.  Strong support on EUR/GBP lies at 0.8400.   Cable has been unable to hold its gains this morning.  Risk aversion and USD strength implies most USD crosses are likely to find the going tough.  

AUD/USD has consolidated its position following last week's sharp fall.  Speculation that the China will slow the pace of monetary tightening is supportive for Australian exports.  That said expectations of fiscal tightening in the industrialised world have caused markets to re-price forecasts for world growth; as evidence in the recent declines in stock indices.  As long as risk aversion persists, AUD/USD could struggle.  AUD/EUR, however, may perform better with the recent correction lower likely overdone.    

US existing home sales are due this afternoon. Jane FoleyResearch 207 398 5024