European stock indices have mostly given up their opening gains. In tandem with the reigning in of risk appetite this morning, bond yields are generally a little lower and the USD and the yen better bid. While overnight news was dominated by better June trade data from China which has helped counter fears of a stalling in the global recovery, European markets cannot escape fears that next Friday's publication of the results of bank stress tests could bring negative results.

Germany's Handelsblatt has suggested that tests will be stiffer than recently reported. This raises the prospect of more failures. Adding to this, reports have been circulating that Germany's Der Spiegal is suggesting that Germany favours a plan in which an orderly insolvency of indebted euro-area countries would involve forcing bond holders to give up part of their claims. EUR/USD has eased back towards 1.2560 this morning, EUR/JPY has been pushing against the 111.20 level.

Sterling is also weaker against both the USD and the JPY this morning, though it is presently trading off its lows. Sterling weakened on the back of the as expected UK Q1 GDP report (+0.3% q/q), this being accompanied by a far worse than expected deteriorated in the Q1 current account deficit (to -GBP 9.6bln). The detail of the GDP report showed that government expenditure rose by 1.5% q/q. This support is expected to go into reverse in Q3 and beyond as the government honours its pledge to restore public finances to health.

While UK Q2 GDP is likely to register relatively decent growth, more doubt surrounds the prospects of the economy in the current quarter. Sterling has now given up its post-budget gains vs the EUR suggesting it is likely to be less sensitive to bad domestic news than in recent weeks. Given the EUR's sensitivity to concerns about bank stress tests, there is scope for some downward potential on EUR/GBP near-term.

Weekend election saw Japan's DPJ party lose control of the upper house. This implies a period of some confusion as the LDP grapples to find new coalition members. While this may have negative implications for PM Kan's recently stated enthusiasm to start tackling the budget deficit, near-term this is unlikely to impact the yen's status as safe-haven currency.

AUD/USD has edged away from its intraday lows. Overnight loses followed news that Chinese imports for copper and iron ore were lower in June. That said an increase in home loan approvals in May has stoked speculation that the RBA may resume a tightening policy this year.

US earnings season will be a key focus this afternoon. There is no US key data scheduled.

Jane Foley

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