EUR/USD is holding moderately higher levels this morning (above USD1.2260).  The JPY is weaker across the board with the crosses moving into consolidative ranges.  Cable has followed EUR/USD to slightly higher levels and EUR/GBP, while off this morning low is trading below yesterday's range, revealing a slightly more constructive tone in sterling.  Consistent with the lower appetite for safe haven, Bund yields have retreated off yesterday's lows and stocks are pushing higher.

The better tone in stock markets this morning begs the question as to whether the bout of re-pricing is complete.  Re-pricing was necessary to allow for the fact that the fiscal repair process in the Eurozone and in the UK and US will cap growth prospects over the next few years.  This did not sit comfortably with the exuberance of the rallies in assets such as oil and stocks earlier this spring. That said recent US economic data has been sufficiently robust to allow many forecasters to draw the conclusion that the US recovery is now self-sustaining.  The Fed recently revised higher its growth forecast for this year to 3.45% and growth will help erode the appallingly huge US budget deficit.  The relatively better US economic outlook will likely help strengthen the USD's position in the second half of this year particularly given the fact that in Europe there is still the risk that further bad news will emerge.   Fears that the European banking sector is sitting on bad debts will be sufficient for the market to remain nervous and for the EUR to remain under pressure medium-term.   This morning there were unconfirmed reports that Treasury Secretary Giethner, who is due to arrive in Europe today, has called for all European banks to undergo stress tests.  This week's failure by the small Spanish savings bank Cajasur has drawn attention to the fact that the Spanish property crash may yet bring bigger causalities.  On top of the risk that Greek debt may yet have to be re-structured, this is of particular concern.  Outstanding Greek debt is in the order of USD350 bln; to put this in perspective, the Russian debt default in 1998 was in the region of USD73 bln.   Reprieve for the EUR is likely to be short-lived, a move towards its average rate of USD1.18 is likely in a 1 to 3 mth view will a move significantly lower still on the cards.  On a more encouraging note, the Italian government has approved a EUR 24 bln deficit reduction over the next 2 years.  Yesterday's Spanish t-bill auction was well received.  However, today's Portuguese EUR 1 bln 2015 auction was met with a bid/cover ratio of just 1.8, yields were pushed higher to 3.701% from an average yield of 3.498% in a similar auction in Feb.

Yesterday's Queen's speech did assert deficit reduction as a primary concern for the new UK government.  Sterling is holding better levels vs the EUR this morning tough the mood is consolidative.  The reported rise in BBA loans for house purchases was lower than expected and signals that the recovery in the housing market is far from robust.  While the economy is still vulnerable, the publication of the OECD's UK Economic Outlook has confronted the UK high inflation rate and called for rate increases from the BoE before the end of the year.  This is not consistent with the dovish tone of the BoE suggesting that sterling will not get significant support from these calls.  That said sterling stands to benefit vs the EUR from deficit reduction pledges.  Near-term support lies at EUR/GBP 0.8485.

The AUD has won back some ground vs the USD in line with the increased appetite for risk.  Strength in the Westpac leading economic index and comments from the OECD that Australia may require further 'rapid'' rate increases will offset some of the recent talk that the RBA may be on hold through the summer.  AUD/EUR continues its recovery trending higher towards 0.6800 initially.  

US durable goods will be released this afternoon.  US new home sales and the Canadian house price index are due. The Fed's Lacker is scheduled to speak. Jane FoleyResearch 207 398 5024