Strong economic data from both Germany and the UK injected some life into the risk trade during the European morning. The data offset many of the earlier jitters surrounding this afternoon’s release of the EU’s bank stress tests. While a nervous banking sector continues to weigh on the FTSE 100, generally stocks indices have traded moderately higher this morning. The weaker tone of the yen across the board, and the better tone of the EUR the AUD, NZD and the CAD vs the USD this morning were also suggestive of increased risk appetite. However, these currencies have already given back some of their morning gains.

The Spanish press this morning reported that some of Spain’s savings banks have failed the stress tests. While the official publication of the tests is not due until 16:00 GMT, the failure of these banks is consistent with the broadly held view that this section of the banking system is perhaps the most vulnerable in Europe given its exposure to the burst Spanish property bubble. Although there has been a fair degree of optimism in recent days that most banks will pass the tests, the outlook for the banking sector is still mired by constraints on profitability implied by tougher regulations and by the relatively high costs to banks of raising longer-term funding; the latter being of prime concern to banks that perform poorly in the stress tests.

While the banking sector will dominate attention today, economic data provided a strong diversion. The German July IFO survey surged to 106.2 in July, outpacing both the market consensus and the June data by a generous margin. The release comes on the heels of yesterday’s stronger than expected German PMI data and provides more evidence that Germany’s economic recovery continues to gather pace despite the loss of momentum in the US economy. Both the current and expectations components of the IFO surprised on the upside. Recent German surveys have shown some hesitancy in the expectations components, so today’s result suggests that the impact of the sovereign debt fears may have peaked. The current disparity between US and German economic data provides an interesting backdrop for today’s essay in the FT from Trichet which talks up the need to tighten fiscal policy. While there is little risk that the ECB will hike the refi rate at least before the middle of next year, Euribor continues to creep higher; this is likely to offer EUR/USD decent near-term support. EUR/USD reached an intraday high of USD1.2964 this morning before edging lower. The USD1.2700 support continues to hold solid, risk is for another run at the USD1.300 level near-term.

Sterling outperformed both the USD and the EUR this morning on the release of much better than expected UK Q2 GDP. GDP rose 1.1% q/q with strength registered in production, services and construction. While fears that the economy will struggle in H2 on the back of austerity measures will persist, it seems the UK economy is in far better shape to face the cut backs than had been expected; the highest forecast on the Bloomberg survey was for a rise of +0.9% q/q. Stronger growth suggests diminished risk of double dip recession and reduces pressure on the government’s budget. The ability of cable to take out the USD1.5330 resistance strengthens to technical backdrop for the pound. EUR/GBP is presently pushing against the GBP0.8330 technical support, a close below this level could signal a move lower.

Talk that the Japanese authorities could be on the brink of intervention continues to circulate, although we perceive the risks to be small. Strong Australian Q2 import/export data underpinned the Aussie vs the JPY into the early part of the European session, though profit-taking set in mid-morning.

Canadian CPI is due for release this afternoon.