Risk aversion heighted by China.
S&P warns on Jpn.
UK only just drags itself out of recession - sustainibility of growth questioned.

Talk that China may accelerate the pace of monetary tightening shook the markets overnight. Fears rose on the back of a wire report that selected Chinese banks will have an additional increase in reserve requirements enforced upon them from today. This sparked a move into the USD and the JPY; though the JPY suffered a sharp but temporary correction on news late in the Asian session from S&P that it was lowering its outlook on Japan's AA credit rating from stable to negative. Safe haven buying has taken USD/JPY down to a low of JPY89.41 this morning, EUR/USD has printed a low of USD1.4075.

S&P's decision was made on the view that the diminished policy flexibility of the Japanese government heightened the risks of deflation and worsened the fiscal outlook. By contrast Moody's stated this morning that it was currently not concerned about Japan's ability to finance its debt. As the worries about the S&P warning faded safe-haven buyers re-emerged in the JPY. Also supporting the JPY was the policy announcement from the BoJ. As expected the BoJ confirmed unchanged rates but counter to market speculation it announced no new target for purchases of government bonds. The lack of fresh action from the BoJ prompted a comment from Finance Minister Kan that he will be telling parliament this week that he expects the BoJ to help fight deflation. This statement hints of a continued spilt between the BoJ and the MoF and suggests that the BoJ will remain under pressure to take further action in the comings weeks which could undermine the outlook for the yen.

Sterling was dealt a heavy blow this morning on the release of a much weaker than expected UK Q4 GDP report. At +0.1% q/q, the release confirmed that the UK economy finally dragged itself out of recession in Q4. However, the pace of growth was below the lowest estimate on the Bloomberg survey and has led to a resurgence of concerns as to how the UK economy will fare during 2010 when fiscal incentives are due to be lifted. Comments from BoE Governor King that he agrees with Obama insofar as radical reform is needed in the global banking sector may also have undermined the pound. Cable has been unable to regain its poise currently trading close to the session lows at 1.6116, similarly EUR/GBP is trading back at 0.8750.

Better news for the EUR came yesterday in the form of better than expected demand for Greek 5 yr government bonds. More good news came this morning in the form of the better than expected German IFO index. Counter to the consensus, the expectations component rose. This is a relief given this month's projections from the German statistically agency that the pace of the economic recovery stalled in the final months of 2009. While the EUR has gained vs the GBP, it has been struggling to recapture ground vs the USD, pulling only modestly higher from the session low.

This afternoon news on the Portuguese budget will be of interest. In the US, house price data, consumer confidence and the Richmod Fed manufacturing index is due.

Jane Foley
Research Director