Investors move out of risk,
Cable grapple with QE talk and stronger USD,
more bad news for the AUD.

Investors moved away from risk today as poor economic data from Australia and NZ stirred pre-existing concerns over deficit issues in Europe. EUR/USD edged below its recent lows to an intraday low of 1.3828, EUR/JPY pushed down as far as 125.52 before finding a little support. The mix of USD strength and speculation that the BOE may announce further QE at today's MPC meeting has pushed cable to a low of USD1.5825.

The results of the Spanish 3 yr auction provide a window on investor sentiment in Europe. Yields on the paper were driven up to 2.6% from 2.14% on the last 3 yr issue in December and today's bid/cover ratio was a respectable enough 1.85. Although this bid/cover was far lower than that managed by last month's Greece 5 yr issue, the results of the Spanish auction are better than many feared and have lent the EUR a little support this morning. That said, the European Commission is yet to give its response to last month's Spanish budget and in a year where Spanish unemployment is threatening the 20%, the outlook is far from good. The continued rises in the cost of Portuguese credit default swaps this morning further highlight the risks for the EUR going forward.

Having avoided recession completely last year, Australia's economic cycle is far more advanced that other industrialised nations. Given its relatively strong fundamental backdrop, the decision by the RBA not to hike rates earlier in the week was a surprise to the market and news of a -0.7% m/m decline in Dec retail sales this morning was another shock. Insofar as these data followed a poor pre-Christmas sales performance by major retailer Woolworth, this news was not entirely out of the blue. Even so, AUD/USD fell further in Asian hours and declined to 0.8783 in London hours. Given the additional shock of a surge in NZ unemployment in Q4, Asian stock market mostly end the session lower and buyers moved back into the JPY and the USD. Tomorrow, the release of the US non-farm payrolls data is likely to provide fresh and strong direction for risk appetite.

Cable hit a low of USD1.5825 this morning as the market grappled with the discussion over whether the BoE will announce an increase in QE. Surveys suggest that economists expect no change in policy today either in rates or in the asset purchase program. However, the release of weaker than expected UK Q4 GDP data last week (+0.1% q/q) has stirred talk that further QE may be announced. Ample availability of cheap funds within the banking system, however, does not necessarily increase the will of businesses and consumers to make use of these funds. The savings ratio increased in the UK last year (as it did in the Eurozone and the US) as debt was paid back by consumers. The persistence of low s.t. rates is likely to prove a more effective way of supporting the economy at this point of the economic cycle and QE is likely to be paused. GBP is likely to see a fillip higher if steady policy is announced. However, recent opinion polls suggesting that a hung parliament is a possible outcome in the spring general election suggests sterling could be in store for a difficult few months.

The ECB will also announce policy today. The market will be looking for any remarks on Greece, Spain and Portugal. In accordance with the stance adopted in Jan, Trichet is unlikely to entertain any notion that EMU could be broken up.
US factory orders and initial claims data, Canadian Ivey PMI and building permits data are due today.
Jane Foley
Research Director