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The better mood that propelled European shares higher by 3-4 % yesterday has persisted at the European open although gains are more muted. Things are much quieter in FX this morning as investors wait for the ECB and BOE meetings later to set the tone.


· Europe is still dominating things, this time the prospect of a region-wide bank re-capitalisation programme is having a positive effect on risk appetite. The European authorities can act quickly when they want to and ever since it was announced that Franco/ Belgian bank Dexia would receive government support EU authorities have spent the last 48 hours trying to ensure no other Dexia's start to come out of the woodwork. The European Banking Authority is (finally) conducting stress tests on banks that measure their sovereign exposure. This may boost the capital shortfall to EUR200-300 billion, much higher than the EUR 12billion shortfall announced in June at the last stress tests.

· Most banks are fully funded for this year, the risk is that in the first three months of 2012 banks in Europe need to raise nearly EUR200 billion. In the absence of private sector interest to boost banks equity levels, governments in Europe needs to get a recapitalisation plan in place ASAP.

· It seems that EU-wide negotiations to deal with the sovereign crisis have stepped up a gear: 1, Germany has thrown its support behind the bank recapitalisation programme and 2; reports suggest that the IMF could step in to help shore up the bonds of troubled Eurozone governments. However, this is unlikely in the short term since it would require some sort of alternative financing since the IMF is not allowed to intervene in the bond markets.

· France is still a spanner in the works - it is resisting calls for government support to back-stop the banks, probably because if it had to help recapitalise its troubled lenders then its triple A rating would be at risk. This is one of the major problems with the bank recapitalisation efforts - there needs to some sort of joint funding so that countries like France don't see their credit ratings put at risk.

· The BOE and ECB meetings are in focus. Read our BOE update to get our view.

· We expect both banks to remain on hold today, although we, like consensus, are expecting the ECB to announce long-term funding measures to provide liquidity to the banking sector along with a continuation of its Italian and Spanish bond-buying programme.

· Of course the main news dominating the papers today is the death of Apple's Steve Jobs. We don't think this will have an impact on the overall market; however that doesn't lessen the tragedy at the passing of a man who proved to the world that technology could be elegant.

Market action:

· News that Europe is moving quickly to help its banking sector is continuing to boost confidence. Banks led the overall index higher yesterday and are up again today. In the short-term the banks are crucial to overall market performance.

· The sharp move higher in stocks yesterday could be an indication that stocks had over-shot on the downside and are due a pull back. Thus, we may see further gains. But a sustained rally requires the US economy to create jobs, so tomorrow's payroll data is still the week's key risk event.

· The Hang Seng had a storming session in Asia, even though the latest PMI data in Hong Kong fell to 45.9, down from 47.8 in August. The financial sector makes up more than 50% of the Hang Seng, so if the banks recover this has a particularly large impact on the index.

· FX markets and credit markets haven't shared the same exuberance as the stock markets. EURUSD and GBPUSD are flat to slightly lower today and we may tread water until the BOE and ECB meetings later on. Any announcement of QE from the BOE would likely cause the pound to weaken across the board. Although QE is expected, most people are looking for it to be announced next month. GBPUSD may see back to the Sept 21 lows at 1.5350 if the BOE surprises the market.

· In contrast, a cut from the ECB may well support the euro later today as it would help boost growth. As we mentioned yesterday, Europe is slipping behind the UK and US in the growth stakes ( so looser policy from the ECB may help raise growth expectations. Above 1.3350 in EURUSD opens the way towards 1.3400 and then 1.3455.

· Credit markets are less straightforward. Eurozone bond yields have opened higher in Spain, Italy and Greece and German bond yields are lower today suggesting stresses remain. However, US Treasuries - the ultimate safe haven - saw yields rise as investors' dipped their toes back into risk markets.

· Gold is stuck in a range between $1,600 and $1,700. Above $1,644 - the 100-day sma - opens the way towards $1,755. However, the precious metal is likely to move inversely to the dollar for now and in the very short-term investors don't seem to want to hold the buck, so that is good news for gold.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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