On May 19th Greece is obliged to repay EUR 8.5 bln of maturing debt. Altogether its May funding need is around EUR 10 bln and with Germany dragging its feet there is still no guarantee that the EU will provide the loan that was promised some weeks ago. The IMF is reportedly preparing to make good some of the shortfall and increase the size of the loan that it had previously promised. Meanwhile the German government is reportedly trying to raise funds in a more politically acceptable way by pressuring existing German holders of Greek debt to cough up some of the EUR 8.4 bln that Germany is compelled to lend Greece as part of its EU obligation. Standing between the German government and its cheque book is the May 9 regional election in North Rhine Westphalia. While the election in NRW is not being fought on the subject of Greece, the issue gives an added edge to concerns about lack of fiscal manoeuvrability in the region. NRW has had to issue a record EUR 27 bln this year. Over the past 10 years or so the amount of debt per capita has soared. This increase in debt and the possibility that the level of local services will have to be cut to meet fiscal consolidation targets does not sit happily with the notion that German taxpayers may have to make funds available to Greece. The lack of German popular support for a loan for Greece is probably also felt by other tax payers in the region. But as the EU's largest contributor the German electorate must now realise that if it does not provide funds to Greece the possibility that EMU could collapse comes significantly closer. The markets have responded to this risk by bidding ever higher bond yields in other EMU peripheral countries in addition to Greek. The Portuguese government has been expecting to open a new bond in Q2. Fuelled by this week's credit downgrade, the yield on Portuguese 10 yr bonds is this morning pushing close to 6%. If yields rise much further Portugal may, like Greece, be in a position where issuance on the open market becomes just too expensive. This would increase the needs for further loans from the EU/IMF. Clearly the need for the EU to staunch contagion is urgent. However, the fundamentals suggest this may be an impossible task. The markets will only be reassured that EMU's deficit issues can be overcome when the data start improving. However, it could be months, even years before this happens. At the core of the problem is that Greece, Portugal, Spain and Ireland desperately need to improve their competitiveness. But, without the ability to devalue their currencies workers will have to see the relative level of their wages drop instead. The alternative is that Germany stimulates domestic demand to absorb the exports of its EMU neighbours. Returning to NRW, however, there is little appetite for additional spending. If relative wage cuts prove too big for Greece to tolerate (and for other EMU countries struggling under large deficits) and if Germany has no appetite either to boost its domestic demand or send bailout payments, then EMU could be approaching a stalemate situation. Some kind of managed default starting with Greece is probable, an exit from EMU for Greece is a possibility. The alternative is that Germany could remove itself from the system; a move which would almost certainly result in the collapse of EMU. EUR may have a significant falls still in store.

Risk aversion sapped the strength of the AUD this morning despite strong Aussie CPI data. The yen, however, has been weakening ahead of Friday's BoJ meeting and talk that the further policy measures may yet be on the cards. Sterling has been pressured by comments from former MPC member Beasley that the UK economy remains in a fragile state; cable has seen an intraday low of USD1.5151.

The FOMC will be closely watched today for any change in rhetoric. Canadian house price data are also due.

Jane Foley Research Director FOREX.com jfoley@forex.com +44 207 398 5024