EUR/USD bravely attempted to claw back some of yesterday's losses in Asian hours. However, sellers dumped the EUR during the European session as economic data reminded the market that this year's fiscal and debt issues in EMU have not evaporated. While most eyes were focused on the Fed at the start of this week, the situation in the European periphery took a turn for the worse.

Attention yesterday was focused on Ireland with the bond spreads vs Bunds blowing out on fears about the mounting costs of the bailout of Anglo Irish bank. The spreads have improved a little today as the Bank of Ireland dismissed the movement in bond markets as spasms. That said the focus on Ireland had heightened market nervousness sufficiently for the EUR to take a heavy hit this morning on the release of worse than expected Jun -0.1% m/m industrial production data and on poor Greece GDP data.

The Greek economy shrank by 1.5% q/q in Q2, this being the seventh consecutive quarter of contraction. Even though the budget figures from the government have improved this year quicker than most had been expecting it is an arithmetic certainty that with no growth Greek debt will continue to rise until the budget deficit is completely eradicated. The EU has forecast that Greek debt would rise to 133.9% of GDP in 2011 from 124.9% in 2010. Today's worse than expected GDP data gives credence to forecasts that the debt could expand to 150% of GDP.

In turn there is still a tangible risk that Greece could be forced into announcing some kind of debt default. If the ECB continues to reign in liquidity provision, this risk may be increased. While the German economic recovery has recently surpassed market expectations, the ECB clearly has a difficult path to tread.

While Eurozone debt issues will almost certainly come back to haunt the EUR again, it is unclear whether this week's news from Ireland will spark a renaissance of the Eurozone fiscal concerns. German Q2 GDP is due tomorrow and strong data here could prompt some buying in the EUR. Technical support lies around the EUR/USD 1.2600 level suggesting that while EUR/USD holds above the uptrend in EUR/USD has not yet given up the ghost.

USD/JPY rose in early European hours this morning as the market became wary about intervention ahead of a Japanese MOF press conference. In the event there was no real news and USD/JPY fell back towards closing levels. The usual remarks that the MoF is watching fx markets will soon be seen by the market as little more than an empty threat. Comments from the MoF's Noda that excessive currency moves are harmful to the economy are not only a statement of plain fact but do not raise the risk of intervention at all. The ECB has concluded that intervention may actually be a cause of fx volatility, this factor is one of many that is likely to keep the MOF from intervening yet.

The USD's recovery has pushed cable back towards USD 1.5580 this morning, though sterling is holding its own vs the EUR trading close to 0.8220. The BoE may have darkened the mood in the UK yesterday but budget data remain a prime focus for the sterling markets and next's week PSNCR data will be a prime domestic market focus, better GDP in Q2 and the previous set of terrible data suggest some scope for an improvement.

While the weaker USD is Asian hours supported AUD/USD, poor Australian labour data has weighed on the AUD.

US initial claims are due this afternoon.

Jane Foley

Research Director
+44 207 398 5024