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The big news over the weekend was that Germany's Angela Merkel has reportedly given in to pressure to boost the size of the Eurozone's rescue fund, and will now allow the EFSF and ESM to run alongside each other from this summer.

This is a breakthrough of sorts; it will boost the rescue fund from less than EUR 400bn today to about EUR 750bn after you account for bailouts for Greece, Portugal and Ireland. This was a compromise agreement, according to reports. The European Commissioner for Economic Affairs Ollie Rehn, had wanted more dramatic changes including boosting the fund to EUR 900bn and allowing the EFSF and ESM to run alongside each other permanently. This was too much for Germany who wants the EFSF to come off line once it expires next year.

Since it appears that this boost to the bailout funds will only be temporary the markets' reactions have been fairly muted. Stocks in Europe have opened down and the euro is under pressure, having failed to make traction above 1.3280. Right now 1.3200 looks vulnerable; however after a fairly sharp move lower so far in the London Session the euro may pause at this important support level as investors wait to hear more details of the rescue fund changes and whether or not the ECB will also step up its support after Spanish and Italian yields started to creep higher last week.

There is a lot weighing on the markets this morning. Firstly, the Spanish Prime Minister failed to gain a majority in Andalucía at key regional elections over the weekend. This is causing concern that the new PM Rajoy's plans for fiscal consolidation may be harder to push through than first envisaged. Already Italian PM Monti has put the pressure on Spain, saying over the weekend that Spain needs to push ahead with tough fiscal reforms and do more to reign in its budget deficit. This highlights an interesting political shift in the Eurozone: the new fiscal pact allows more interference in member nations' budgets and fiscal plans to ensure the survival of the currency bloc. However, it will be interesting to see how Spain reacts to Italy's advice especially since budgets were once sacred issues of national sovereignty and the new unity in the currency bloc could take some getting used to.

Added to that the Finance Ministers of the Eurozone meet on Friday in Copenhagen where they may ratify the expansion of the bailout fund. There is a hurdle, however, in Finland. Its leaders have said they won't agree to any changes to the current bailout structure until the IMF commits more money (exactly the opposite of what the IMF has been saying) so there could some political wrangling later this week, which may increase uncertainty in the markets as investors question whether there is the will within the Eurozone to create a firewall that could contain a crisis in Spain and/ or Italy. This could make it very tough for the euro to gain traction in the coming days and a 1.31- 1.33 range may persist for the next couple of days.

European stocks could also remain under pressure. After clawing back some losses at the end of last week the boards are a sea of red yet again. European stocks have been led lower by Spanish stocks, possibly on the back of Rajoy's performance in the regional elections. Interestingly Spanish and Italian bond yields have fallen today. Later we will hear how many bonds the ECB bought through its SMP programme; it will be interesting to see if it picked up the pace of purchases after a dramatic drop in recent weeks post the LTRO auctions. It has always been our view that the ECB will need to buy actual sovereign debt (not just offer cheap bank loans) and the Eurozone governments will need to boost the firewall to ensure this crisis is brought under control this year.

The markets easily brushed off the better than expected German IFO index. This was a key European release because of the extremely weak PMI survey data for March released last week. The expectations index jumped to 102.7 from 102.4 in February, the highest level since August 2011. This index was fairly strong across the board. Although manufacturing sentiment dipped slightly, interestingly, the retail sector rose dramatically in March relative to February, suggesting that the German economy could be on a self-sustaining path. However, it remains troubling that the IFO has diverged from the PMI survey, which we will discuss in another research note later this week.

Although the markets are in risk off mode today the yen has started to weaken after clawing back some losses last week. This is to be expected as it's the last week of the fiscal year in Japan that is typically yen negative. Although USDJPY sold off sharply on Friday, 82.25 support held (also the 21-day sma) which suggests it was a normal pull back and not the end of the recent up-trend.


Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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