European stock markets failed to cling onto their opening gain as risk appetite took a turn for the worse. In line with this trend, the CAD has given back ground vs the USD this morning despite expectations that the BoC could hike rates again today. Also, AUD/USD is also off its overnight high. Pre-empting the softer tone in stocks has been the failure of EUR/USD to hold above the 1.300 level. From an intraday high shortly after the London open at 1.3024, the EUR has backtracked to just a whisper above 1.2900.

The results of the Greek, Spain and Irish debt sales have on the face of it been encouraging. Increased demand for Spanish bills drove down the average yield at its auction. The treasury sold its maximum EUR 6 bln allocation at a bid cover of 1.95 and an average yield of 2.221%. 18 mth bills were sold at a bid/cover of 2.44 and an average yield of 2.331%. Ireland managed a bid/cover ratio of 3.6% at its 2020 and Greece sold 13 wk bills with a bid/cover of 3.85 at its auction at a uniform yield at 4.05%. These governments are paying a lot to secure finance in the open market but the fact that there is demand does diminish the risk of sovereign default in the Euro area at least in the immediate future.

That said, the high costs of securing funding will place additional pressure on budgets and heighten the need to make painful and potentially unpalatable austerity measures. It will be some months yet before countries such as Greece and Spain can hope to shake off the mantle of the walking wounding and in the interim concerns about the coherence of the Eurozone could surge again.

As news of the first casualty of the EU bank stress tests was reported this morning, the market appears to be questioning whether tensions in the Eurozone have eased sufficiently to justify gains for the EUR above the EUR/USD 1.300 level. Much of EUR/USD's recent recovery has been drawn from the market's reappraisal about the outlook for US growth and interest rates. The market no longer expects the Fed to hike interest rates much before the ECB and this has been reflected in the cheaper price of the USD. That said, fears of a double-dip recession in the US have most likely being overstated and this suggests that the USD's downward adjustment may now be largely complete.

Hungary failed to reach its target at its bill auction this morning following yesterday's failure of the government to reach approval from the IMF and the EU for its budget. The HUF did find support this morning though this was on the back of speculation regarding possible central bank intervention.

Intervention talk has also contributed to a softer JPY this morning. Although yen strength will not be desirable by the Japanese authorities, stand-alone intervention is not a policy that the MOF would adopt lightly.

Sterling sold off this morning on the back of worse than expected PSNCR data. While disappointing the net borrowing data do show an improvement in the trend. June borrowing registered GBP 14.5 bln compared with an upwardly revised GBP 17.1 bln in May with increased tax receipts helping to improve the outlook. The tough budget pledges of the new governments are a prime focus for the market, though the impact of the squeeze will not register until later in the year. This week's Q2 GDP data is likely to indicate a decent pre-budget performance for the UK economy and may win back some support for the pound. Tomorrow's BoE minutes are also a focus.

The BoC is widely, though not universally, expected to hike interest rates today. The impact of any move should be largely priced-in and may be subdued if the accompanying statement from the BoC downplays the need for follow on moves.

US housing starts and building permits data are due today, along with the BoC decision.

Jane Foley

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