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There are two forces working on the markets right now: 1, central banks in simulative mode and 2, fragile recoveries and tail risk from Europe. Both have been out in force today. Earlier Eurozone economic data for Q4 2011 actually surprised to the upside, GDP contracted by 0.3%, better than the 0.4% fall that was forecast. 

France's economy managed to stay above water in the last three months of 2011, while Germany didn't contract as much as expected, although Italy slipped into a technical recession after its economy contracted 0.7% in Q4 after falling 0.2% in Q3. The market took the GDP data in its stride, after all everyone in the market expected weakness at the end of 2011 and now people want to know how quick the recovery will be in 2012. What was far more interesting were reports that French car maker Peugeot had apparently approached the ECB about EUR 1bn of loans that are backed by collateral. So has the ECB has replaced the entire banking system in Europe, or what?

We don't know if this plan by Peugeot would be accepted, but it leads one to question the integrity of the ECB's balance sheet in the wake of the LTRO programme. It also suggests that some corporates would consider cutting out the middle man (the banks) and going straight to the source of the funding - the ECB. This is another way of admitting that Europe's banking sector is up the creek without a paddle, and the even though risk may be rallying post the ECB liquidity injection, banks in Europe are still in a critical state.

On the topic of central banks and liquidity the Bank of England presented its first Inflation Report of the year. The report came after some fairly depressing labour market data. Although the unemployment rate remained steady at 8.4% (the lowest level since 1995) the claimant count rate rose more than expected in January by 6.9k, vs. 3k expected. There are now 2.67 million people unemployed in the UK, which is an increase of 48,000 over the last 3 months. Added to that wage growth remains below the rate of inflation at 2% per year, which suggests that inflation will have to fall further to stimulate consumption.

The Inflation Report was slightly less downbeat compared to the November report. Although the Bank of England still expects inflation to fall below target in the medium-term, it doesn't expect the dip below 2% to be as deep as previous. It also added that the extent to which inflation will decline and the likely pace of moderation remain uncertain. Added to that its growth forecast was revised higher with the growth recovery pushed forward to Q1 from Q2 and Q3 previously.  Some have taken this to mean that QE is not necessarily a given. However, BOE Governor King said that more stimuli is possible and even though the Bank owns close to a third of all UK Gilts it could still buy more.

He also added that any tightening ion policy would be detrimental to the overall economic recovery in the UK and since the bulk of public sector spending cuts won't come into force until 2013 and 2014 the Bank will need to maintain an accommodative stance for some time. The pound has traded in a very tight range today. GBPUSD has traded between 1.5680 and 1.5720, it is moving with overall risk appetite although the revisions higher to the BOE's inflation and growth estimates contained in its Inflation Report is limiting pound weakness. It also helped trigger the sell-off in EURGBP after it reached 0.8400 - a harsh resistance zone where EURGBP has faltered before.

Overall, the European session has been a bitty day, with no real trend noticeable and instead fairly tight ranges are prevailing. Whether or not risk can cling on is dependent on Greece. Read more below....

Greece watch:


Europe is still dominating the markets for the wrong reasons. After it seemed like Greece had jumped through all the hoops necessary to release its next round of bailout funds, yesterday we heard that Greece had failed at the last hurdle. The Eurogroup meeting scheduled for 1700 GMT today has been downgraded to a teleconference after the head of the Eurogroup said that Greece had failed to meet all of the demands necessary to receive the next tranche of funds.

It appears that the latest stumbling block between Greece and its next tranche of funds (read welfare) from its Eurozone peers is down to EUR 300mn of extra cuts and getting signed requests from the leaders of Greece's major political parties that they would implement the cuts agreed regardless of the outcome of April's general election. This was a bone of contention, the centre right leader, at one point last night, refused to sign the agreement. The Europeans smell a rat, and after dealing with successive failures from Greece to meet fiscal targets it is refusing to give the country the money.

The latest update is that a bridging loan could be arranged for Greece that would cover its EUR 14.5 billion bond redemption coming up on 20th March. However, the other EUR 115.5bn of funds wouldn't be released until after elections in April.  This is not exactly the outcome that the markets were waiting for as it increases uncertainty. Markets would like to know that Greece has enough liquidity to stay afloat for the medium-term, however so far that certainty has not been forthcoming.

The reason is that no one believes Greece will need just one more bailout. What happens when its latest EUR 130 billion of funds dry up? It's unlikely that Greece will be getting more funds from irate German, Dutch and Finnish politicians who barely hide their contempt for the Med nation.

It's not just Greek-fatigue that is bolstering markets as Athens continues to flounder, it's also because since 2010 banks across the world and in Europe have been reducing their exposure to Greece and its sovereign and private sector debt. Barclays announced results last week and it now only has GBP 13 million of exposure to Greece, which is nothing for a Bank the size of Barclays. Added to that BNP Paribas, the French lender, is exposed to the tune of EUR 1.6bn, which is about EUR 3 billion lower than at the end of 2010.

Thus, the markets are not reacting as they once were to negative headlines from Athens because they are less exposed and thus less sensitive to events in Greece. This is also the case for the economic future of the Eurozone. The core is outperforming the periphery and even France, who is also trying to reduce debt, managed to export its way to growth during the last three months of 2011 expanding by a modest 0.2%, while Greece saw its economy contract 7%.

So maybe there are legs to the argument that Greece matters less to the Eurozone now than it did before, and if the European leaders can negotiate an orderly default or exit for the Eurozone then it may only have a limited impact on markets. This may be why European stocks and even peripheral bond markets have proven to be fairly resilient to the current crisis in Athens.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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