EUR/USD is holding comfortably above its February lows on the hope that a bailout for Greece will avert a crisis in the EMU.  That said the EUR has not been able to extend the gains notched up earlier in the week.  The market is correct to be cautious.  Help for Greece at this point will indeed band-aid the situation.  However, it cannot disguise the fact that fiscal frictions within the EMU run deep and that there are insufficient controls in place to ensure that various countries have adequate incentives to reform their budgets and to maintain budgetary prudence.  This crisis raises the question as to whether a monetary union is sustainable in the long-run without stronger fiscal policy controls.  However, insofar as this questions the sovereignty of member nations, this has been an issue which EU countries have been sidestepping for decades.  

The general consensus is that budgetary management in Spain and Ireland in recent years has been better than that in Greece.  This view is reflected in the wider spreads on Greek bond yields and supported by the fact that the public debt/GDP ratios of these countries remain below the Eurozone average.  That said neither Spain nor Ireland is out of the woods.  Both could see further contraction in growth this year and while Ireland has already transitioned debt caused by the bursting of its housing bubble from the banks on to public sector, Spain could yet find itself in a similar position.  The situation in Greece vindicates the criticism that many countries 'fudged' the entry criteria for EMU back in 1999.  Ahead of EMU entry Greece had a history of needing support from Europe and abandoning structural reform suggesting that it was always optimistic to assume that it could cope well with a deep recession.  Any 'solution' that EU ministers may find for Greece at their summit today should not be considered as an end to the issue but rather as a start to a prolonged series of discussions as to how fiscal controls within EMU can be strengthened.  While ministers may be able to push the present crisis under the carpet, the issue about fiscal controls could persist for years.  As a consequence EUR/USD is likely to continue with its downward adjustment this year.  

Good news in the form of better than expected Australian jobs data overnight resulted in talk of a March RBA rate hike and a spike higher in AUD/USD to an intraday high of USD0.8904.  By contrast NZ data was poor with business PMI slipping back to 52 in Jan from 53 in Dec.  This resulted in a surge in AUD/NZD and a drop in NZ stock indices in contrast to the general positive tone of Asian bourses.  Lower than expected Chinese inflation data and the implication that further PBOC tightening may be moderated helped the mood overnight.  The PBOC pledged this morning to keep the yuan basically stable but indicated it will improve the yuan's exchange rate mechanism.   

Cable bounced from the 1.5560 level this morning, just ahead of the technically crucial 1.5540 channel base, this has led EUR/GBP lower.  However, given yesterday' dovish BoE Inflation Report and fears that the spring general election could bring a hung parliament, sterling remains vulnerable.

US initial claims and Canada's new housing index are due today.
Jane Foley
Research Director