Trading cable of late has not been for the feint hearted. Another sharp move lower at the London open today (to USD1.4980) was followed by a squeeze up to USD1.5120. A war of words between the UK Treasury Chief Secretary Byrne and the EU Commission was responsible for some of this volatility. A leaked report from the EU called for additional measures to tackle the budget deficit. Byrne remarked that the the EU has got the judgement wrong given the government's intention of cutting the budget deficit to 5.5% of GDP (from around 13% at present) in 4 years time. The sensitively of the pound to these remarks highlights in part the unavoidable truth that the deficit is a serious concern but it is also a function of the fact that the main two political parties have still not outlined any specifics as to how they plan to reduce the deficit. The March 24 budget will no doubt bring some clarity, though sterling will be vulnerable on any pre-election sweeteners which Chancellor Darling may announce. Supporting the short-covering in sterling this morning was the publication of more market friendly opinion polls. In comparison to the weekend YouGov opinion polls which gave the Conservative opposition only a 4 point lead over the Labour party, two polls conducted yesterday shown a widened lead for the Tory's; a YouGov poll gives a 5 point lead, a Opinium poll suggests a 11 point advantage for the Tory party which is consistent with a clear majority.

The EUR was slow to react to last night's news that the EU was ready to act to support Greece. The lack of any detail on the plan overnight was most likely behind the delayed reaction. EU Finance ministers have clarified an arrangement that would allow them to take coordinated action with respect to providing emergency loans. The optimal result of this strategy would be that its very existence will be sufficient to bid market rates lower; allowing Greece to carry on funding its debt in the open market. Greece faces having to roll over around EUR 55 bln of debt this year and clearly wishes to do so at cheaper levels than of late.

Insofar as this system pushes Greece further away from crisis, this is a good step forward for EMU and should lend short-term support for the EUR. However, it does not address the fact that the fiscal controls that exist in the EMU are inadequate. Discussions as how to encourage greater fiscal prudence are likely to continue and are necessary for the integrity of the EMU going forward. The German ZEW survey was stronger than expected at 44.5. However, it registered yet another decline from the previous month highlighted the ongoing fragility of the German economic recovery which in turn serves as a reminder that at current levels the EUR is still a strongly valued currency. The recovery in EUR/USD has stretched as far as 1.3716 this morning.

Japanese Fin Min Kan stepped up the pressure on the BoJ to announce further policy measures after this week's regular meeting. Kan stated that the central bank can make an inflationary impact with monetary policy. Despite widespread speculation that the BoJ will increase the size of last Dec's emergency lending facility, USD/JPY pushed lower overnight though speculation of widening interest rate differentials did lead USD/JPY higher in European hours. Following recent comments from the Fed's Evans there is some speculation that the Fed may drop the reference to rates remaining low 'for an extended period in tonight's policy meeting. The majority, however, expect this phrase to remain.

USD/CAD has continued to meander its way towards parity this morning. This afternoon Canadian manufacturing sales data are due. US housing starts and building permits will also be released.

Jane Foley
Research Director