EUR/USD is holding above its session low of EUR/USD1.3290. The ECB's Trichet has removed some pressure on the EUR by announcing that the ECB would extend emergency collateral rules beyond 2010 - thus removing from Moody's the power to decide whether Greek sovereign debt can carry on being eligible as collateral at the ECB beyond the end of this year. Also, Chancellor Merkel has clarified that she sees loans from the IMF only as last resort which has implied that there is still hope that the EU will come through with a solution for Greece ahead of the summit which starts at 5pm this evening. There is now much more riding on the decision regarding Greece than what will happen to Greece in the short-run. Greece will find funding this spring; though it is still uncertain whether this will come from the EU, the market (with EU guarantees) or the IMF. More important that that is how well the EMU can restore its credibility. The difference in views from key founding members over how to tackle Greece's fiscal difficulties has highlighted a dangerous lack of political coherence. This must be addressed to prevent the growth of speculation that the EMU could prove unworkable over the long-run. For many years EMU successfully sidestepped the argument that monetary union is unsustainable without fiscal union. This agreement is currently gaining more momentum and not purely as a result of the problems in Greece. Germany is also being blamed as being partly responsible for adding to the pressures on the EMU. By maintaining downward pressure on wage growth and conservative fiscal policies (which have contained domestic demand) Germany has built up trade surpluses which are now considered potentially destabilising. In order to match Germany's competitiveness, a country could either cut wages or devalue. Alternatively Germany could sour its competiveness by revaluing which would relieve some pressures on its struggling Eurozone neighbours. Clearly the options of revaluing/devaluing are not available while a country is within the Eurozone, suggesting that the issue that the EMU may move forward in a different form is on the cards. While the Irish have cut some civil servant nominal wages by 20%, clearly this is not an option which would be easily digested elsewhere. Almost certainly many Greek, Portuguese and Spanish workers would rather accept a devalued national currency than a nominal wage cut. Clearly politicians have a lot of work to do sweep speculation of an altered EMU under the carpet, in the meantime EUR/USD could see lower medium-term.

PBOC Deputy Governor Zhu Min suggested overnight that Chinese lending growth will see further moderation in March. This would ease some of the immediate fears over asset prices bubbles and relieve fears of further imminent policy tightening.

USD/JPY has broken above the 92.00 level casting aside selling pressures by Japanese exporters. The pressure on USD/JPY is in part a function of general USD strength but owes a lot to the push higher in US rates yesterday following early selling in the 10 yr futures and then on a poor result for the 5 yr note auction. The 7 yr auction today will be keenly watched.

Cable surged higher on the back of the better than expected headline Feb retail sales data (+1.6% y/y). The enthusiasm was dampened, however, by the huge downward revision to the Jan data (to -2.1% m/m). While 3m/3m sales volume in Dec to Feb fell 1.4%, seasonally adjusted data are showing an improvement. Gains for cable have been capped by USD1.4980.

Fed Governor will be speaking this afternoon; the market will be looking for clarity on exit policies. US initial claims data are due.
Jane Foley
Research Director