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There are two things dominating the markets right now: 1, the Eurozone debt crisis and growing political risks and 2, central bank policy. The Federal Reserve starts its two day meeting today, which will conclude tomorrow with a press conference by Fed Governor Bernanke.

Central bank divergence is a major theme in the markets right now. Weak Australian CPI and PPI data has made a rate cut at the RBA's May meeting all but a certainty. The question now is will the Bank cut by 50 basis points (more than 30 bps of tightening is priced in right now) in May, or cut by 25 bps in both May and June. The latter seems more likely to us as a 50 bp cut is an aggressive move, however, rates in Australia are still fairly high, and so there is room for successive cuts form the RBA.

The Norges Bank has also been talking on the dovish side. Governor Olsen sounds worried about a strong Nokkie causing deflationary pressure. This is eroding the NOK's carry appeal as the Bank could cut rates further to try and combat currency strength.  Likewise, there is a lot of noise in Japan about the strength of the yen. The Bank of Japan is expected to increase the size of its Asset Purchase Programme between 5-10 trillion yen when it meets on Friday and to extend the maturity of its government bond holdings from 2 years to 3 years.

On the other side of the spectrum you have the Fed and the BOE. The Fed is not expected to change its forecasts for interest rates when it meets this week. However, there has been some moderation in the dovish tone coming from some Fed policy makers in recent months, so it will be interesting to see if there is any change to the FOMC' s median interest rate forecast. Even a small change that brought forward rate tightening from the late 2014 prior forecast is likely to be pounced on by the market and could send the dollar flying north.

Although the pound is moving around with overall risk sentiment the more hawkish tone to the BOE minutes from its meeting earlier this month has sustained the pound's uptrend. GBPUSD remains well supported above 1.6060 - a prior resistance level that is now key support. The shift in stance from former uber-dove Adam Posen helped jolt sterling bulls into life.

Somewhere in the middle is the ECB. ECB member Nowotney said yesterday that if the sovereign debt crisis notched up a gear then the ECB could act in a forceful way. However, he said there is no point lowering interest rates (as French Presidential candidate Hollande has campaigned for) until the full impact of the LTRO's is felt. There is a large contingent in the market who already believe more action is necessary and the LTRO's failed since all they did was pump Europe's banks with cheap money, which increases their exposure to dodgy sovereign debt and to margin calls to the ECB.

This is the first time in years that the developed world has had such divergences in policy, but for the forex trader this is all good news as it opens up the possibility that markets will start to move on the back of fundamentals rather than risk on/ off.

Overall today, Eurozone political risks prevail. The markets are digesting what political disillusionment in Holland and France really means for the future of the Eurozone. Holland had to sell debt today, which went off relatively ok. It sold EU 1bn of 2014 bonds with a yield of 0.523%, and a small amount of 25-year debt. Spain also sold short term debt fairly easily this morning; however, it had to pay up for it - the yield it had to pay on 6-month debt worse to 1.58% vs.  0.836%.

Peripheral bond yields in Europe (does that officially include France and Holland yet?) are lower, the euro is higher and stocks are recovering as we wait for the FOMC. The pound shrugged off weak public finance data, which showed public sector borrowing rise GBP 18.2bn vs. GBP16bn expected. Tomorrow's GDP data is the key release for the pound this week. New home sales in the US and consumer confidence are the data highlights later today.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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