The inability of European stock market indices to hold their opening gains this morning suggest that underlying doubts about the global economic backdrop are proving difficult to shrug off. In line with the easing in stocks, the yen and the Swiss franc have won back a little ground today. In recent sessions, there were a number of signs of confidence ebbing back into the markets. The softer tone in both the JPY and the CHF earlier this week signalled improved risk appetite. In addition, the sell-off in gold, the upward creep in treasury yields yesterday and the tightening in the yield spread in peripheral European bond spread have all pointed to a more optimistic mood this week. The perception that the brunt of fears surrounding a European sovereign debt crisis may now be in the past is also detectable in the policy position of the ECB. Last week the ECB bought the lowest amount of bonds since its bond buying support program was launched in May. Euribor has also been ticking higher and ECB President Trichet has been vocal in his support for budgetary repair. The ability of EUR/USD to push back to the 1.3000 level this week is also a function of this more confident tone. While sterling’s recent gains have been built around stronger than expected UK data, the better tone of the pound this week was no doubt been fuelled by the more relaxed attitude with respect to risk. This morning cable’s upside bias appears to be stalling.

While fears about sovereign default have come off the boil, it would be foolhardy to completely dismiss the prospects of an orderly default or of haircuts from a European sovereign in the next year or so. It would also be unwise to overlook the likelihood that growth in the industrial world will continue to face headwinds both from fiscal austerity and from continued relatively tight credit conditions. The watering down of Basel III may mean that bank regulation has a lessened impact on growth going forward. However, the changes made to Basel III were likely made largely because many countries already faced with stressed budget deficits and slow economic growth could ill-afford to have the screws tightened further by reduced credit availability. This morning’s release of the ECB’s Q2 lending survey reports that renewed constraints in banks’ access to funding and liquidity were key factors underlying tighter credit policy. Politicians must accept that tighter regulation for banks is not necessary consistence with the need to get economic growth back to trend levels.

EUR/USD has skirted around the 1.300 level this morning with the confidence in the EUR sapped as risk appetite dwindled. Cable has failed to hold above the USD1.5625 area and is trading in a sideways fashion. This morning’s testimony of the BoE’s MPC to a Treasury Select Committee indicates that Governor Kind is cautious about reading too much good news into the stronger than expected Q2 GDP release and indicated that there was a considerable way to go before policy could be normalised. While dovish tones are evident in the words of Fisher, Sentance maintained his more hawkish position.

The AUD suffered a setback overnight on the release of weaker than expected CPI data. This furthered the likelihood that the RBA will keep policy on hold for some months. AUD/USD has found decent support just above USD0.8920.

US durable goods and the Fed’s beige book will be key this afternoon.