China blasts its way back into the headlines,
EUR taking it from all sides

The Peoples Bank of China blasted its way back into the headlines this morning by announcing a 50 bp increase in reserve requirements. The data follows just a day after news of a surge in M1 (39% y/y) and reports of continued sharp rises in house prices. However, insofar as the CPI release yesterday was lower than expected, many investors have clearly been wrong footed by the timing of today's news. The risk trade has been crushed on the back of the Chinese news, AUD/USD has free-fallen back to the USD0.8830 area, AUD/JPY plummeted to 79.00 as all the JPY crosses benefitted the FTSE 100 index, oil prices and the EUR have all been hit hard.

The EUR has been taking it from all sides this morning. China's policy tightening coincided with the announcement of weaker than expected Q4 Eurozone GDP at just +0.1% q/q. The market had been prepared for this poor performance by the earlier national releases of GDP. The German economy failed to grow in Q4 2009, Italy shrunk by -0.2% q/q. France put in a much better performance at -0.6% q/q but given that EMU's next biggest economy, Spain, also contracted in Q4 (-0.1% q/q), the legacy of the final months of last year is clearly not good. The German statistical agency had last month warned that the German economic recovery slowed significantly in Q4 which had already pushed expectations for growth lower but zero growth was the very bottom end of the range of market forecasts for today's data. This news had already tightened the screws on an already vulnerable EUR. Having remained mostly steady through Asian hours, the print of the German GDP coincided with another leg lower for the EUR leaving EUR/USD teetering on the brink of another test of USD1.3600 before the news from China broke sending the EUR back below USD1.3560.

Greece's economy contracted by -0.8% q/q in Q4. The inability of the economy to shrug off manacles of deep recession before an austerity program is even launched can only intensify the scepticism surrounding Greece's ability to reduce its deficit by 3% of GDP by the end of 2012. While EU Finance Ministers have acknowledged that they have to support Greece, the absence of any detail on how they will proceed only displays the difficulties they are having in reconciling the need to maintain coherence in the EMU with the reaction of their electorates to potential demands that they step up their already substantial support to Greece. Clearly the European Commission's rules on fiscal management are inadequate. This issue will have to be addressed by EU officials; a process which might take years. Greece's fiscal problems have served as a reminder to the markets that fiscal mismanagement is a threat to monetary union. Until EMU finance ministers can prove that they have rules in place to deal with these issues, the EUR is likely to maintain its downward adjustment.

The Swiss National Bank managed a small share of the headlines this morning with suspected intervention in EUR/CHF. Arguably the timing was poor; although EUR/CHF leapt higher, most of the gains have subsequently been reversed as the market shortens EUR positions.

The release of Jan retail sales data this afternoon will steal some attention back to the US economy. Given the market's present appetite for safe haven, there are likely greater upside risks for the USD today. University of Michigan confidence survey is also due.
Jane Foley
Research Director