The EUR was showing signs of stability at the London open, but this did not last. EUR/USD has pushed back below last night's close to an intraday low of USD1.2263 ahead of the US open. Concerns over the resilience of the US recovery, weak technicals in the S&P 500 and renewed concerns over the health of UK banks following the publication of a BoE report have all increased risk aversion ahead of this weekend's G-20 summit in Toronto. In reflection of this, stocks are weaker in Europe this morning, the JPY is pulling back some of its earlier loses vs the USD and the AUD , CAD and NZD are all lower.

Relief that the banking sector has won a victory with respect to the implementation of the Basel III regulations did not extend far. The Basel recommendations on the need for banks to maintain a longer term 'net stable funding ratio' to protect themselves in the event of another financial crisis will be watered down following intense criticism that this would have a significant detriment impact on economic growth potential. The victory was soon overshadowed by the warning from the BoE that the UK's economic recovery could be at risk if domestic banks do not quickly raise the GBP750-800 bln it estimates is needed to finance borrowing.

This news will hit a sector already smarting over fears of non-performing loans which could be uncovered in the European banking sector in the months ahead. Earlier this week the President of the Banque de France, Noyer, warned that some banks (in Europe) were already having difficulties raising capital. This was followed by reports suggesting that some banks in Greece, Ireland, Portugal and Spain were particularly reliant on the ECB for capital. Given that the ECB's 12 mth EUR442 bln loan is due to expire nervousness may rise some more. Tension in the interbank market continues to be described by the elevated position of Libor. More broad-based concerns surrounding debt defaults are reflected in this morning's widening in the sovereign yield spreads of Spanish, Portuguese and Greek bonds vrs German. Yesterday the Hungarian 12 mth bill auction was only just covered which also reflects widespread caution on the behalf of investors. Faced with the uncertainty over potential defaults, the EUR is likely to remain on the back foot through the summer months.

Sterling took a clear hit on the news from the BoE concerning the UK banks funding pressures. Cable dropped from the 1.4970 area back to 1.4880 and EUR/GBP climbed back to 0.8270 before the EUR was sold again. While the headlines of the BoE report are deeply worrying, the Bank did concede that the resilience of the banking sector has improved since the BoE last reported in December.

The theme of banking reform is expected to be tackled during this weekend's G-20 summit. Though pressure remains for the officials to appear unified, diverse national interests is hindering the ability of the G-20 to show a common front in the area of both banking reform and over the pace of fiscal repair. It is unlikely that the weekend meetings will offer any firm directions to fx markets.

Australian dep PM Rudd has confirmed that the country will retain a mining tax under the leadership of new PM Gillard though suggested that she is open to negotiation on specifics. Following a stable tone overnight, AUD/USD has softened in London reflecting increased risk aversion.

US Q1 GDP revision is due this afternoon as is final university of Michigan confidence.

Jane Foley

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