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It was a quiet session in Asia and European stocks are expected to open slightly lower. The euro traded in extremely tight ranges overnight, EURUSD only moved 50 pips, the Aussie also traded sideways in Sydney hours and Asian stocks followed their European and US counterparts higher as these markets wait for Europe to open to gauge market sentiment.

There are some risks for today. The first is German GDP for 2011 released at 0800 GMT. It is expected to show a 3% annual growth rate, which is below the 3.6% rate from 2010, however it's still fairly resilient, possibly reflecting the boost to growth from a very mild winter. But markets always look ahead so it's the 2012 estimates that are important for market sentiment.  This is slightly less encouraging as the German Economic Institute announced that it believes German growth could slow to a mere 0.6% annual rate this year, and that's only if the Eurozone doesn't blow up.

Although Fitch said yesterday that France is unlikely to be downgraded this year, investors shouldn't get too complacent. Standard & Poor's still has France on ratings watch negative and could strike in the next few weeks. Investors may have been soothed by some fairly good debt auctions for the Netherlands and for Austria yesterday. Austria was the bigger test due to its banks' $40bn exposure to struggling Hungary.

Investors may be willing to go long equities this week, but they are also hedging themselves and flocking to the safety of German and US government debt. Germany managed to sell 6-month debt for a negative yield on Monday and yesterday the US sold 3-year notes at a fairly measly 0.37% - this auction attracted the strongest interest since 1993! So the bond market is definitely telling us that fear is alive and well and so is the belief that central banks will do everything they can to ease the situation and that includes the ECB.

There was some fairly dovish commentary from Fed officials overnight. The Fed's Pianalto said that the neutral unemployment rate was 6%, and it could take the US 4-5 years to get to this point, added to this the Fed's Williams said that he saw glacial pace at resolving the housing crisis - the main stumbling block to the US employment recovery. This dovish testimony hasn't changed the direction of the dollar, which has been higher in recent days, but it has taken the edge off as it suggests any deterioration in US economic data going forwards could cause another round of QE, which is negative for the greenback.

Today markets could be fairly range-bound to neutral as investors wait for the ECB. As we mentioned previously we don't think the Bank will embark on formal QE anytime soon, but it should pledge more support to the banking system. It will be interesting to hear Draghi's verdict on the first 3-year LTRO auctions before Christmas. So far they seem to be extremely ineffective. On Monday night banks deposited more than EUR 480 bn with the ECB, which is only slightly less than the amount of long-term debt the banks borrowed from the ECB. So expectations that banks will use this money to buy sovereign debt seem optimistic.

Tomorrow's ECB meeting comes after two pivotal debt auctions: Spain and Italy auction debt on Thursday, while Italy announced yesterday it would also auction EUR 2-3 bn of 2014 bonds on Friday on top of EUR 1-1.75bn of 2014 and 2018 bonds it was scheduled to sell, so someone in Rome must believe market conditions will suck up Italian debt even though bond yields are rising.

We continue to think the trajectory for the euro is lower across the board but especially vs. the dollar and yen, as we lead up to these risk events. Negotiations with private sector holders of Greek debt seem to be stuck with some hedge funds refusing to accept haircuts on March debt, having bought the debt at a premium - mostly from banks - on the expectation they will get paid out and Greece won't default in March. There are few winners from this situation: either hedge funds get there way and Greek debt levels aren't substantially reduced, or the EU/ IMF force all bond holders to accept haircuts and Greece gets its way and imposes retroactive collective action clauses in all its bond contracts - thus making a mockery of the entire European financial system and word of the law. This could have a knock-on effect on other European bond markets and may worsen the debt crisis.

We could trade between 1.2670- 1.2820 in the near-term in EURUSD, although we tend to think 1.25 isn't too far away. Merkel/ Monti and Lagarde/ Sarko meetings are the highlight along with a German debt auction at 1015 GMT.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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