EUR/USD has bounced sharply higher since the start of the European trading session.   From 1.4274 just after the open the USD fell all the way back to just a shade below 1.4400 as the market gets its teeth back into the risk trade and on a reluctance to hurry a move in USD/JPY back above 93.00.  Expectations that the BoJ will keep rates close to zero at least through 2010 and its commitment to avoiding deflation last month switched the mantle of favoured funding currency back to the JPY.  However, having rallied throughout Dec, USD/JPY may be taking a breather.  Insofar as the market is still speculating that US rates are likely to be raised this year, it is likely that upwards momentum in USD/JPY will reassert itself.  That said, comments from the Fed's Kohn that lingering credit constraints are a key reason why I expect the strengthening in economic activity to be gradual is evidence of the ongoing debate over whether or not the first Fed rate hike of the cycle will be delayed.  

News that Chinese manufacturing activity recorded the second fastest rise since April 2004 was the principle cause of the boost in risk appetite overnight.  AUD/NZD reached an intraday high of 0.9063, the NZD has rallied as far as USD/NZD0.7274.   

Sterling has pushed higher vs the USD on the back of the USD's weaker tone.  EUR/GBP has had a mixed session pushing lower initially on renewed risk appetite and, despite a pullback, winning back its gains on a round of better than expected UK data.  CIPS PMI manufacturing data for Dec rose a better than expected 54.1 which will strengthen the widely held belief that the UK economy strengthened in Q4.  The rise in mortgage approvals was also sufficient to keep alive the notion that the UK housing market recovery remains in place.  UK Dec M4 data was also revised higher to 9.3% y/y.  However, this is still a lacklustre pace of growth.  While some see the  lack of strength in M4 as a reason why the BoE should increase QE, equally it may seen as suggesting that QE is an inappropriate tool for stimulating the real economy.  The MPC are due to meet this week.  However, there is unlikely to be any real discussion on QE until the February meeting which coincides with the publication of the next Inflation Report.  Chancellor's Darling reiterated this morning that the UK budget deficit will be halved in a 4 year period.  Tory leader Cameron announced on Jan 1 the start of the opposition's election campaign suggesting an increase of pre-election party positioning in the months ahead.  PM Brown has hinted that the general election will not be called before May.  Looking ahead sterling is vulnerable on fears that the election could produce a hung parliament. 
Eurozone Dec manufacturing PMI data this morning was in line with market forecasts at 51.6.  Swiss PMI was weaker than forecast, but still expansionary at 54.6.  EUR/CHF has bounced from the 1.4810 area on nervousness about potential SNB intervention.  

This afternoon, US ISM data will be key this afternoon.  

Jane Foley
Research Director
+44 207 398 5024