This of course relates to whether or not the European authorities will expand the EFSF's size to EUR2-3 trillion. The only sustainable solution to this crisis is: 1, funds available in case Spain and Italy (maybe France) get in to trouble, 2, a recapitalisation of Europe's banks , which may cost EUR300bn according to IMF estimates and 3, an ability to protect the ECB- who holds in the region of EUR60bn of Greek debt - in the event that Athens defaults. These are big problems to solve and will cost Europe's taxpayers a lot of money and that is where the snag is.

The Spanish finance minister came out today and said that there were no plans to boost the EFSF to EUR 2 trillion. This was bolstered by a German government spokesman who said that the largest economy in the Eurozone has no plans for EFSF expansion past those agreed at the July 21 summit. Likewise, the German and Greek premiers have denied that there will are plans for a default - orderly or not - in the pipeline. So the market may have jumped the gun. While global officials may want to speed along a process to solve the sovereign debt crisis it appears that Europe is going to stay on its slow, plodding path. Before we can start talking about a new enlarged fund, the German parliament needs to accept the changes agreed in July. Although this is likely to be passed, German politicians may put conditions on further bailout attempts, which may pour cold water on the G20's proposals.

This remains a complex issue to solve. If a solution is forthcoming then it justifies the recent rally in risk - European stocks markets are broadly higher by 2-3% today. However, investors are still short on detail so we would urge caution. However, it does strike me that relative to the last major sell off in the euro- at the time of the first Greek bailout in early 2010- the single currency hasn't fallen that far. Don't get me wrong, it's had a large 10 big figure drop, but it fell to 1.1800 previously and we are a long way from there today. This suggests a couple of things in my view: firstly that if things get a worse then we have much further to fall, and 2, that long-term money including central banks and institutional investors have not ditched the euro. Thus, we have seen the EURUSD claw its way back above 1.3500 even though there is no end in sight to the debt crisis.

Italian and Spanish bond auctions today were swamped with demand, but only for higher yielding debt. Both nations sold a total of EUR17.7bn, but Italian 182-day bills yielded 3.071% up from 2.14% at an auction in August. Both countries are paying much more for debt today and longer term investors are remaining elusive, thus Italy and Spain are still living on a hand-to-mouth existence.

Spain has one more bond redemption left this year of EUR14bn and expiring bills worth more than EUR20bn, so it needs demand for its debt to remain well supported. If the ECB agrees to expand its covered bond-buying programme at its meeting next week then we may see some easing of pressure on Italy and Spain, however there is a lot of internal and external resistance to the ECB expanding its role in this way so don't count on anything.

Elsewhere, Eurozone money supply data was much stronger than expected in August. Growth in loans to households grew last month even as financial market volatility picked up. Loans to the private sector grew by 2.6% on the year, even as activity data pointed to a slowdown. There is a risk that this won't last as there have been some announcements from some of the region's most beleaguered banks that they intend to de-leverage in the coming months. The overall money supply is growing at a 2.3% annual rate, up from 2.1% in July. This may put off the ECB from cutting interest rates too soon, as this could boost inflation pressure. Market expectations are increasing that the ECB could cut rates as soon as next week; however there is a still a vocal hawkish faction at the Bank. An ECB official from Finland today said that the Bank needs to keep inflation under control for next year. Adding to that, it is Trichet's last meeting as President next month - rather than undo the rate cuts he supported he may try and help Europe's banks in other ways like proving long term loans etc. This would probably have a more beneficial effect on the economy and the markets since rates in Europe are still negative and remain at low levels even after the hikes. This is definitely something to watch. There is an expectation of rate cuts currently being built into the market. If this fails to happen then it may be euro positive as the markets re-adjust.

The pound is moving higher along with other risky assets, although CBI reported sales suggest that consumption in the UK remains weak, the index fell to its lowest level since May 2010. Ahead today US house price data and consumer confidence will be important barometers of the US economic health.

For now, risk seems willing to brush off concerns that Europe will fail to enact bold measures to stem the sovereign debt crisis, although more and more signs are pointing that way. We shall have to see if markets have false confidence or if EU officials can be forced into closer fiscal and economic unity.

Data Watch:
14.00BST (0900 ET) US Case Shiller house price index Last YoY 4.4% exp, 4.52% last
14.00BST (0900 ET) EU Juncker speaking at the European Parliament plenary in Strasbourg
15.00BST (1000 ET) US Consumer Confidence Last 44.5 Exp 46.0
17.30BST (1230 ET) US Lockhart (FOMC Non Voter) Speaking on the US Economy
18.20BST (1320 ET) US Fisher speaks on why he voted against Operation Twist
21.40BST (1640 ET) CD BOC's Senior deputy Governor Macklem speaking
00.00BST (1900 ET) UK BOE Publishes statement on Financial policy Committee meeting

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Kathleen Brooks| Research Director UK EMEA |

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