Prospects for an aid package that would provide loan guarantees to Greece coupled with conditions that might reduce the threat of moral hazard are dominating currency market sentiment ahead of a key EU summit on Thursday. And while the dollar is slightly higher against the euro and a basket of currencies of its major trading partners, that hasn't prevented headstrong dashes north for the euro as investors continue to cover increasingly shaky short positions.

Euro - Critical to any outcome on Thursday - indeed if one even emerges - is that the EU walks away undamaged by compromise. A workable solution that provides Greece with loans from its fellow member nations would likely come with strings attached that would dissuade other members from ever falling into the same fiscal trap as Greece has. A solution that leaves an untarnished view of the ECB and European Union intact could spell an end to the recent soft patch for the euro. That still leaves a mountain of short bets against the euro built in very recent history when there appeared no prospects of resolution. The potential for a positive solution leaves such positioning as nothing more than what's looking like a very risky gamble on a collapse in confidence over the future of the Eurozone.

The euro rose on media reports that German officials said a workable solution was on the table, although French denial that there was a nearby solution sent the euro lower. It is, however, becoming clearer that ministers are working towards a German-spearheaded deal. The euro rose to $1.3815 before falling to $1.3760 before U.S. markets opened. 

Against the yen the euro was a shade easier at ¥123.20.

U.S. dollar - The dollar is continues to hold its ground as an unwitting bystander to European drama. The dollar index remains marginally above 80.0 as investors await a prepared statement this morning from Fed chairman Bernanke. Inclement Washington weather means that many offices remain closed in the region, while the remarks will address the Fed's proposals for winding down quantitative provisions aimed at tackling the weakened economy and what to do with monetary policy in the aftermath. It's unlikely that remarks will cause any market shocks.

British pound - The pound dropped against the dollar to $1.5626 after a dovish quarterly inflation report delivered today by the Bank of England. The pound also eased against the euro to stand at 88.03 pence. The Bank said that it may yet have to resort to quantitative easing in order to ensure CPI doesn't dip below target. That seems like a sign that anemic growth is set to remain worrisome. On the present market path of interest rates the Bank projects that inflation would still leave inflation below target two years forward. The pound continues to weaken on fears that the economy isn't feeling the same vigorous rebound felt by other developed nations.

Aussie dollar - The Aussie dollar felt the benefit of rising risk preference on Wednesday rising to 87.98 U.S. cents before easing to

87.61 cents. A positive reading of its export performance with China offset a dip in a reading of consumer sentiment. While overall Chinese export figures rose 21% in the year through January the data disappointed economists looking for a 28.5% improvement. Australian exports to the Chinese economy growing at a frenzied 10.7% pace rose a staggering 106% in the same year to January. Firm Asian stocks helped sentiment towards the Australian dollar.

Japanese yen - The yen jumped to ¥89.25 per dollar after a wider than forecast U.S. trade deficit for December. In Japan overnight there was also good news in the form of a 20% rise in machine tool orders, which was twice the predicted pace. The rise is a positive development and eases concern over recent fragile capital spending, which might be hindering economic growth.

Canadian dollar - The Canadian dollar continues to hold its own versus the U.S. dollar and is broadly unchanged at 93.64 U.S. cents. Crude oil and gold prices are both lower to begin trading although this doesn't appear to be detracting from the value of the Canadian unit.

Andrew Wilkinson

Senior Market Analyst