It has been a quiet session thus far with UK data providing the only real news of the day. That said there are signs of a little anxiety returning to the EUR, with EUR/USD dropping down to 1.2270 early in the London session and the JPY crosses showing a reluctance to soften significantly. Fears are rising that Spain could soon be a source of a negative shock. It has been reported that the IMF's Strauss Kahn will be making a trip to the country on Friday.

While the market can draw some comfort from the decent demand seen at last week's Spanish 3 yr auction and yesterday's good response to the Spanish bill auctions, it is still possible that appetite for the forthcoming longer dated Spanish bond auctions may be less pleasing. Not only that but the admission this week from the Spanish Treasury Secretary that the credit freeze affecting Spanish banks and corporations is definitely a problem has stirred fears that a crisis could be brewing in the private sector.

The Spanish property market crash will have affected the private sector more directly than the public sector and the closing of the international credit markets to large sections of corporate Spain reflects market tension about the level of private sector debt; though lack of credit could simultaneously bring the problems to boiling point. Clearly, defaults in the private sector could have a heavy impact on the banking sector. The Director General of the Spanish Savings Bank Association has stated this morning that Spain will not need support from an external credit line. It has also been reported that savings banks are in favour of making the results of stress tests public.

At present EU policy makers continue to disagree with publishing stress test result, though market demands for this are rising. Until there is greater transparency with respect to the health of banks within the Eurozone it is likely that indicators of anxiety such as the cost of insuring bank debt and the level of Libor will remain elevated. The existence of this anxiety in the market suggests that the EUR could struggle to make further gains near-term.

In the UK, Chancellor Osborne is expected to this evening confirm his plan to introduce a levy on banks and potentially indicate that banks may have to be split up. UK banking stocks are currently trading higher on the day with the FTSE pushing upwards in line with the trend in other global indices. The pound opened on a soft footing with a poor Nationwide consumer confidence number hitting sentiment. Sterling quicker reversed its losses with the UK labour market data again producing a positive surprise for the UK markets. The claimant count dropped by a greater than expected 30.9K in May and the April ILO unemployment rate eased back to 7.9%.

Also encouraging was the 5K increase in the level of employment in the 3 mths to April relative to the previous quarter. That said, with the government about to take the axe to public sector spending, employment could suffer further this year. EUR/GBP is currently consolidating ahead of 0.8250 but, with the UK markets still encouraged by hopes for an improvement in the level of the budget deficit, EUR/GBP remains in its downtrend on the daily charts.

The failure of EUR/JPY to hold higher levels this morning may be evidence of dwindling demand for risk. This may also be behind the choppy tone of AUD/USD and the higher level of USD/CAD.

US PPI, housing starts and industrial production data are due this afternoon.

Jane Foley

Research Director +44 207 398 5024



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