• Eurozone sovereign fears weigh on markets
  • BOE announcement expected, but next week could be fireworks for sterling
  • Risk is off the menu for today

There has been a bit more life in the FX markets today. The dollar has strengthened across the board on the back of a hint of risk-aversion. This has been sparked by a few factors: rising fears about inflation after the US corn price rose to another fresh high yesterday and widening spreads in Europe's peripheral nations. This is weighing on the euro and the pound and stock markets have also opened lower.

Portuguese bond yields have risen to a record euro-era high above 7.6 per cent this morning. Just as the market thought that Eurozone officials had the crisis in hand and the euro could resume its uptrend, sovereign debt fears have once again crawled out of the wood work. One reason for this shift in sentiment is down to the tone of debate regarding the Eurozone nations that have received bailouts already. The ECB has warned that Greece and Ireland should not default on their immense debts or impose haircuts on senior bond holders. However, investors will not be hoodwinked by the EU and see the chances of Ireland Greece eventually defaulting as fairly high. By dismissing fears about this prospect, instead of trying to come up with an orderly mechanism for default, the EU authorities are causing market jitters. The announcement that there will be a special summit on March 11 to consider new measures to tackle the sovereign issue has not placated investors either, and EU officials may be pushed to deliver answers sooner rather than later.

While EURUSD remains in a range, below 1.3626 - the top of the Ichimoku cloud, then EURUSD could extend its decline.  Euro swap rates have fallen today as investors start to reduce expectations of a rate hike from the ECB if the Eurozone sovereign debt crisis flares up once again. The dollar is the main beneficiary of this, reinforcing its position as a safe haven currency. The dollar has been trading in-and-out of being a growth currency and a safe haven currency. Right now, the outlook for the US economy remains mixed and the Fed remains ready to stimulate the US economy if job creation does not pick up quickly enough,  which is fuelling safe haven flows rather than growth-related flows into the greenback.

The other main event is of course the Bank of England announcement at midday. However, we believe along with consensus that the Bank will not hike interest rates. Today could be a bit of a non-event for sterling, with much more event risk expected next week. Consumer price data and the Inflation Report will generate fireworks for sterling, and sterling bulls should beware. The market will be listening carefully to Mervyn King's presentation of the Inflation Report next Thursday for any signs that the market has got ahead of itself in pricing in interest rate hikes. There are three hikes priced in by the end of the year; this is excessive in our opinion due to the uncertain economic outlook and the fact that underlying inflation pressures remain weak even if headline prices are elevated. If King does suggest that a rate hike is less likely in the near-term, possibly pointing to a first hike in the autumn rather than the spring, then sterling could tumble quite sharply. Below 1.6000, a key support line, we could see back towards 1.5800.

Although the pound is declining on the back of risk aversion, losses gained pace during the European session after some weakness in UK manufacturing data. It fell in December for the first time since April 2010. Since manufacturing has been a stalwart of the UK's economic recovery if it starts to show signs of slowing this could undermine the UK's growth outlook even more and hurt sterling.

The Aussie dollar is also under pressure. Although unemployment grew at a faster rate than forecast in January by 24k versus expectations of a 17.5k rise, most of this gain was in part-time employment and full-time employment actually fell. The Aussie has dropped nearly 100 pips since yesterday and is on the back foot along with other risky assets.

The Swiss franc is also trading with a bearish tone, especially versus the dollar after weaker than expected inflation data.

Overall, the shift out of risk is likely to hit stocks and commodities, boost the dollar and gold could also benefit especially if sovereign concerns in Europe gather pace.

Data watch:

 

12.00 GMT (0600 ET) EU Weber and Nowotny Speaking

12.00 GMT (0600 ET) UK MPC Monetary policy Decision Last 0.5 Exp 0.5

12.00 GMT (0600 ET) UK MPC QE Asset Purchase decision Last 200 bio Exp 200 bio

13.30 GMT (0830 ET) US Initial Claims Last 415K Exp 410K

15.00 GMT (1000 ET) US Wholesale inventories Last -0.2 Exp 0.7

15.00 GMT (1000 ET) IMF Strauss Kahn Speaking

17.40 GMT (1140ET) US Lockhart FOMC Non - Voter Speaking on Debt and Fiscal Policy

18.30 GMT (1230 ET) CD BOC Deputy Governor Murray Speaking

19.00 GMT (1300 ET) US Budget Balance Jan  Last -42.6 Bio Exp -55 Bio

Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com

d: +44.(0).20.7398 5024 | f: +44.(0).20.7929.2010 | e: kbrooks@forex.com| w: www.forex.com/uk

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