Just a day after the market digested the news that Dubai World has escaped imminent default and hours after the Greek government announced initial measures aimed at restoring confidence in its budget the market was hit by more bad news. Austria's 'Die Presse' this morning reported that its three banking supervisory bodies have put the country's 4th largest bank under surveillance. The EUR sank aggressively vs the USD on the news, plummeting to below 1.4540 in European hours before buyers emerged. Market disappointment over the lack of water tight reforms in the Greek budget also contributed to the softer EUR. Other 'risky' currencies also took a tumble. The AUD, which had been undermined overnight by the less hawkish than expected RBA minutes, fell to AUD/USD90.80. The NZD fell to just above NZD/USD0.7210. The release of the German ZEW survey was better than expected at 50.4 in Dec. However, this was the third consecutive monthly decline and did little to buoy sentiment.

As if the Austrian news was not sufficient reminder of the fragile state of the global economy, the IFO's Sinn this morning has stated that the credit crunch remains a big problem for Germany. In addition, Moody's highlighted that countries may have to start cutting deficits before the recovery is strongly established in order to protect AAA ratings. All of this news conspires to project a fairly gloomy economic outlook for the New Year. In essence, it supports the view that interest rate policy of most central banks will remain low for an extended period. Certainly this is the outlook widely expected to come from the FOMC tomorrow. That said the FT this morning speculated that the Fed may push higher its discount rate as soon as tomorrow, this being the rate which the Fed makes loans to the banks. Given that a move in the discount rate would be of psychological importance to the market, this speculation is also likely to reinforce support for the USD.

The minutes of the RBA decision revealed that the decision to hike interest rates in December was a close call. The AUD weakened on the back of the report. However, given that the Dec policy decision was taken ahead of the release of the very good Nov employment report and this morning's strong dwelling starts data, there is good reason for expecting that the RBA will hike rates again before the end of Q1. The NZD has outperformed the AUD this morning. The NZ fiscal update reported that NZ will have a fiscal surplus by 2016, 2 years earlier than previously forecast.

UK inflation data was stronger than expected at 1.9%, close to the BoE's 2.0% y/y target. The data did not have any lasting impact though it heralds a potentially sharp rise in CPI in the early months of next year on the back of the January rise in VAT and on the back of petrol price rises. Sterling has performed very well this morning vs the EUR based on the perceived credit woes associated with EMU, though Friday's UK PSNCR data is likely to be a strong reminder of the UK's own potential credit issues. EUR/GBP fell to the 0.8940 area this morning before buyers emerged.

US industrial production data will be key this afternoon. US PPI, empire manufacturing, NAHB housing market index and ABC consumer confidence in addition to Canadian leading indicators are also due.

Jane Foley
Research Director
+44 207 398 5024