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Even though the Fed's Ben Bernanke made an impassioned plea that QE has benefitted the US economy at Jackson Hole on Friday and it would still be his preferred option to try and boost the economy further, risk assets have come off their Bernanke-induced sugar high and EURUSD is back below 1.26 after reaching a high of 1.2640 on Friday. The limited response to Bernanke could be due to 1, the fact he never mentioned when there could be more QE. If we get a strong payrolls number on Friday does that rule out the prospect of more stimulus at the Fed's September meeting? 2, European concerns have come back with a bang this morning.

ECB trumps Bernanke this week

The big event this week is the ECB meeting on Thursday and then Non-Farm payrolls in the US on Friday. In the last 10 days Spanish bond yields have risen from 6.2% to a high of 6.9% earlier today. They have since fallen back to 6.85%, but they remain perilously close to the 7% threshold level that could twist Spain's arm into accepting bailout funds and the strict conditions bail out loans come with. However, this is the sticking point. Spanish PM Rajoy said in a newspaper article from the weekend that Spain will consider extra aid from Europe on top of its EU100bn banking rescue fund, but that he does not see any need for new fiscal conditions. This flies in the face of the ECB's argument - that it won't buy bonds of Eurozone member states unless the IMF is involved in setting conditions in return for the financial aid.

Watch out for payrolls

So there are a few things that could knock risky assets off course this week: 1, a "disappointment" from the ECB. Even if the ECB announces a new bond-buying programme with all the bells and whistles on it the market has been calling for, i.e. a yield target or a spread target with German debt, if Spain and Italy don't accept more austerity then the new programme is essentially rendered useless. If the ECB can't protect Spain and Italy then who can? Don't leave it up to the German tax payer, a poll at the weekend found that Germany is not happy with having to pay more aid to help bail out troubled nations. France isn't too far behind their German counterparts either. 2, A larger than expected Non-Farm payrolls number. Currently the market expects a 125k rise in the number of jobs. However, if this is more in line with the 163k registered for July then it may make it harder for the Fed to justify more QE at its meeting next week.

This afternoon should be fairly quiet with the US out on holiday. There was a lot of economic data to digest today. German PMI data was the biggest negative shock. It was revised lower to 44.7 for August, down from 45.1 and suggests that Europe's largest economy is coming under a lot of downward pressure. Although this is stronger than the July reading, it doesn't suggest that the German economy is bottoming any time soon.

The UK bucks the global PMI trend

The overall Eurozone figure was also weak, as was China's reading for August. The official Chinese manufacturing PMI data fell to 49.2 from 50.1, which is the lowest level since November 2011. The services sector actually picked up in August to 56.3 from 55.6, however in China the manufacturing sector is still much larger than the services sector, so this is the most important survey.

The UK managed to buck the overall trend, and surprise to the upside. Its manufacturing PMI rose to 49.5 in August from 45.2 in July. This is a big improvement and is close to the key 50 level that indicates expansion. The pound had a very large reaction to the move: GBPUSD jumped to 1.5900, which is a key resistance level. Above 1.5915 opens the way for a move towards 1.60. However, for that to happen we probably need an upward surprise to the service sector PMI to the 53 level, which would be the highest reading since May. EURGBP could also come under more downward pressure due to diverging data signals out of Europe and the UK and the prospect for a dovish ECB on Thursday at the same time as the BOE stays on hold. Below 0.7905 opens the way to 0.7880 in the short-term, which is a key support level.

One to watch: GBPUSD

As we said above sterling had a sharp move higher today on the back of stronger economic data. The pound is the strongest performer across the board today, and if it can break above 1.5915 then we could see the bulls make a break for 1.60 in the coming days, especially if the services sector follow the manufacturing sector PMI reading and also surprises to the upside. 1.5880 - its daily pivot point - should act as good support. Momentum indicators also don't look overbought at this stage, so there could be further upside to come.




Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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