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After voting in a pro-bailout party to government, which gives the Greeks a chance to stay in the Eurozone, it seems to be one nil to Germany as we lead up to the much-anticipated Euro 2012 quarter final match in Ukraine this evening. However could the Greeks pull off a coup and beat their Eurozone masters in a penalty shoot-out? Unfortunately for the Greeks anyone's chances against Germany in a penalty situation are bad. Unless a Hellenic miracle occurs on the pitch Greece is probably more likely to stay in the currency bloc than beat Germany in tonight's game.

Merkel dashes to the Ukraine

All of this talk about football may sound flippant when the Eurozone is in such a perilous state, but even Chancellor Merkel is cutting short a meeting in Rome with Monti, Rajoy and Hollande to get to the match in time. But before she goes to see her national team, hopeful of an easy win against the beleaguered Greeks, she will face some intense pressure from the French, Italian and Spanish leaders' who will no doubt be pushing for her to soften her stance to enhancing he powers of the ECB and allowing the bailout funds to purchase sovereign debt ahead of next week's EU summit. Germany remains opposed to such radical action, but maybe they would have a better chance of influencing Angela tomorrow, especially if her team wins tonight.

The crisis gets serious for Germany

There was further confirmation that Germany is not immune to the slowdown in the Euro area after the IFO index, which measures business confidence, fell in June. The forward-looking sub-index fell to 97.3, from 100.8, which is the lowest level this index has been since autumn 2011, while the headline index fell to its lowest level in 2 years. Combined with weak PMI data and a fall in investor confidence as measured by the ZEW, signs are growing that Germany could see its economy contract in Q2 after expanding by 0.5% in the first quarter. The IFO reported that the economic slowdown is mostly due to a decline in the manufacturing sector, while the domestic sector remains fairly strong as inflation falls and wages start to rise boosting consumption. However, if the Eurozone crisis intensifies then we could see the German economy start to show more signs of strain. Hence the outcome of the EU summit is as important to Merkel as it is to Greece, Spain, Italy and France.

Moody's downgrade tells us nothing new

The European markets have had a lot to digest this morning after the mass downgrade of global banks by credit rating agency Moody's and the results of the Spanish independent bank audit. The downgrades have only had a short-term negative impact on the banking sector in Europe so far. Rating agencies tend to tell us what we know already that the banks are in trouble and some suffer from a short-fall in capital rather than give us anything new to worry about. Spain's bank audit also had a fairly muted impact on the market. The preliminary audit found that banks would need an extra EU50-60bn in the worst case scenario, which is well within the EU 100bn bailout that has been pledged to Spain's banking sector. Markets need to find out: what is the worst case scenario and are we headed towards it now? The Luxembourg Finance Minister said that Spain will submit an aid request in the next few hours to apply for bailout funds to prop up its banking sector. Thus, maybe the current environment is bad enough for Madrid, and if things get any worse in Spain then the EU may need to provide more than EU 100bn in bailout funds.

Since the bailout funds are adding to Spain's debt-to-GDP ratio a formal application for funds from Spain is unlikely to dramatically reduce Spain's government bond yields. IMF chief Lagarde said last night that the Eurozone needs to break the toxic feedback loop between the banks and the sovereigns. But surely if the debt was not transferred to the sovereign it would end up in some shady Special Purpose Vehicle. Essentially someone has to pay back the debt, and although Spain is hardly getting off lightly with its banking sector bailout, the honesty about the funds and where they belong should, in my view, be celebrated by the markets rather than lead to criticism.

Market moves:

The markets have been trading with a risk-averse feel today, but we essentially remain in consolidation territory. This is perfectly normal especially with the EU summit coming up next week. We believe that some interesting ranges could persist for the next few days. In EURUSD we are looking at 1.2450 - 1.2750 (the temporary top from Sunday). After selling off sharply at the European open, EURUSD found support at 1.2525- the 21-day moving average. The US have a habit of coming in and selling risk at the NYC open, so we will be watching closely for the weekly close, if this pair closes below 1.2520 then that may set the stage for further declines next week. EURGBP is another one to watch at the close tonight. If it closes below 0.8080 - the base of the daily Ichimoku cloud - then we could see further declines to 0.8020 then 0.7980.

USDJPY has been a big mover this week, post the FOMC meeting. It has traded in a fairly tight range today and 80.50 is thwarting the bulls for now. 80.10 was a major resistance level for this pair (the base of the daily Ichimoku cloud and end of the technical downtrend). If we close below this level (which is now key support) we could see further losses. Interestingly, the 10-year yield spread between the US and Japan has not widened as some may suspect, as weak global growth fuels demand for safe havens like Treasuries. Usually the yield spread and USDJPY move in the same direction, thus we will be watching this spread and if it doesn't widen further then we could see support for USDJPY start to wane.

Oil is also worth watching as some in the market believe it is looking very oversold. Brent has fallen $10 this week and is at its lowest level since late 2010. It fell below $90 with ease yesterday, but today the bears are taking a breather. After such a large decline, the latest fall in crude could attract some buying interest. After all, we are entering driving and hurricane season in the US and sanctions on oil imports from Iran come into play next month. These events threaten to limit the supply of crude and may limit further downward pressure on Brent.

An SNB official was speaking today and, unsurprisingly, reiterated the necessity of the 1.20 floor in EURCHF. The SNB seems to be intervening through rhetoric to try and limit upward pressure on the franc. While EURCHF volatility has dwindled to almost nothing, it remains perilously close to the 1.20 floor, and if there is a disappointment at next week's EU summit then we could see the market testing the SNB's resolve once again.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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