Risk appetite wanes in Europe;
Greece moves away from the abyss but fiscal issue could weigh on the EUR long-term.

Risk appetite wilted in European hours. Enthusiasm for risk during Asian hours was built around the positive implications from last Friday's US payrolls report in addition to the indications from President Sarkozy that the Eurozone is ready to help Greece if needed. EUR/USD reached an intraday high of 1.3701 in early European trading but subsequently pushed down towards USD1.3630. While last week's oversubscribed Greek bond sale and the passing by the Greek parliament of an addition EUR4.8 bln austerity package has driven Greece await from the edge of the abyss and increased the likelihood that the EU will produce some sort of guarantee that will help cap lending costs for Greece, there is still plenty of work to be done. Firstly Greece still has to prove that it can rein in its budget successfully in the face of civil unrest and in recessionary conditions. Secondly, EMU officials will have to prove to the market that the fiscal controls in place are sufficient to ensure that monetary union can be sustained. The fact that Ireland and Greece both appear to have swallowed the bitter austerity pill is a huge step forward in reasserting fiscal cohesion. However, it will take years for Greece to prove it has good budget credentials and question marks over fiscal discipline could be a long-term drag on the EUR. The incidence of stringent budget reform this year in the relative large economy of Spain as well as smaller ones such as Greece, Portugal and Ireland will also have economic consequences throughout the EMU. Germany is still reliant on exports for growth suggesting that the impact will seep through to the north in addition to the south of the EMU region. Insofar as inflation is extremely subdued in the Eurozone (1.0% y/y) there is very little risk of a rate hike from the ECB well into 2011. The interest rate differential is likely to continuing weighing against EUR/USD, suggesting that while relief could push EUR/USD a little higher near-term, there is room for further downside on a 3 to 6 mth view.

Comments from the PBOC's Zhou over the weekend suggesting that the pegging of the CNY to the USD was part of the 'temporarily extraordinary policy measures needed to weather the financial crisis is the clearest hint that the peg will be relaxed sooner or later. These comments did not elaborate on timing but with the forthcoming CPI release expected to produce the highest number for 16 months, there is growing speculation that the PBOC may allow for a modest increase in the value of the CNY during Q3 or perhaps even Q2 this year.

Japan's Economy Watchers Survey brought better than expected results overnight suggesting the recovery is taking root. Speculation that the BoJ will take further measures to prevent deflation at the March 16 policy meeting have been weighing on the JPY, though EUR/JPY dipped to 123.10 in European hours in line as risk appetite sapped.

In line with the better tone early on cable edged up to USD1.5195 before sellers emerged. While arguably the pound has already priced in the risk of a hung parliament, there remains much uncertainty about how power would be shared after the general election and these concerns when mixed with the need to tackle the huge budget deficit still have the capacity to knock sterling lower in the months ahead. There were no UK data releases this morning.
Canadian Feb housing starts data are due this afternoon.
Jane Foley
Research Director