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  •  Risk-on resumes after Mubarak resigns
  •  China is the world's second largest economy as Japan flounders in Q4 2010
  •  Euro area sovereign problems rear their head once more and weigh on the euro
  •  GBP likely to be choppy as event risks get closer

The week is starting off pretty much as we left it on Friday. The markets are still in risk-on mode after the resignation of Egyptian President Mubarak and the fairly calm transition to military rule until elections later this year. This has boosted risky assets. The Aussie is higher and stocks are also responding well to the end of protests in Tahrir square in Cairo. Oil fell sharply on Friday as threats to global oil supply from protests disrupting trade flows on the Suez Canal were drastically reduced. Oil is consolidating a little at the start of this week, as investors reassess the risks; this is reflected in the doji pattern forming on the daily WTI crude chart, which suggests that bulls and crude bears are fairly balanced for now.

In a fairly light data calendar today investors will be watching the developments in Egypt, particularly the economic impact, which could run into the billions of Egyptian pounds after the economy ground to an almost complete standstill during 18 days of protests. They will also assess the news that China overtook Japan as the world's second largest economy after Japanese GDP for the fourth quarter of last year contracted by 1.1 per cent due to a slowdown in exports and fading in government stimulus plans which hurt domestic consumption. GDP is expected to bounce back in the first quarter as a weaker tone to the yen this year all help to improve Japan's terms of trade position. The yen has had a mixed reaction to the GDP news, USDJPY has come off its highs and the Nikkei also closed higher after a strong showing in the Asia session. Of course, part of this may have been due to Asian stocks moving in line with the improvement in sentiment toward risky assets at the end of last week.

Although China claimed the mantle of second largest economy from Japan, it is still many years from claiming the ultimate title, that of largest global economy. Its economy is just under $5 trillion, compared with the U's economic behemoth, which stands at $14 trillion. But there was a sign that China was rebalancing its economy toward domestic demand, something it will need to do to try and take on the US in the growth stakes in the coming years. The trade balance for January narrowed sharply, the surplus was $6.46bn versus expectations of $11.3bn, after a massive 51 per cent surge in imports, relative to a 37.67 per cent gain in exports. The huge increase in imports was put down to the Lunar New Year holiday on 2 February and also rising commodity prices. However, it's unlikely that import growth of this magnitude can be sustained, and we wouldn't be surprised to see the trade surplus widen in the coming months.

The euro is on the back-foot this week and has had a sharp move lower versus the other major currencies. This is surprising since usually the euro trades alongside risk. However, as we have pointed out before, the euro has been trading more in line with higher yields rather than risk in recent weeks. Yields have come off on the back of: 1, a reduction in interest rate expectations after the ECB toned down its hawkish rhetoric ; 2, a flare up in sovereign debt concerns - Portuguese 10-year yields are currently above the crucial 7 per cent level and press reports suggest the Irish bailout plan is encountering problems; and 3, the uncertainty about succession at the ECB after Bundesbank President Axel Weber resigned from his post effective April 30. This is weighing heavily on the single currency. Industrial production data from across the Eurozone released this morning did little to help matters. It contracted 0.1 per cent on the month, probably due to weather-related factors. But the annualised rate of growth is still a fairly healthy 8 per cent, driven by the core economies of Germany and France.

Ahead this week look out for event risk in the Eurozone and the UK. Italy holds a 15 -year debt auction today, while Spain holds a 15-year auction on Thursday. These will be key litmus tests for investor sentiment towards Southern European debt. Also, the UK's CPI data on Tuesday and Inflation Report and accompanying press conference by Mervyn King on Wednesday will be key drivers of the pound going forward. It could be a volatile few days for sterling, and investors need to strap themselves in tight. The pound has started the week in fairly mixed fashion as investors' demand for dollars pushed GBPUSD down from 1.6080 to 1.6020 at the start of the European session.

Also, watch out for headlines regarding Obama's presentation of the US Budget, it is expected to include some harsh spending cuts to reign in the US's enormous deficit.

Data Watch:
EU Euro Group meeting in Brussels
15.00 GMT (1000 ET) US Dudley (FOMC Voter) Speaking at a regional Economic briefing
02.00 GMT (2100 ET) CN Chinese CPI Last 4.6 Y/Y Exp 5.4 Y/Y
02.00 GMT (2100 ET) CN Chinese PPI Last 5.9 Y/Y Exp 6.2 Y/Y
04.00 GMT (2300 ET) JP BOJ Interest Rate Announcement Last 0.0/0.1 Exp 0.0/0.1

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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