Another day, another headache for the Bank of England. Inflation data for December registered the largest monthly rise since the index began at 1 per cent, pushing the annualised rate to an 8-month high of 3.7 per cent from 3.3 per cent in November. This has fuelled sterling strength and GBPUSD is currently above 1.6000, while EURGBP has erased earlier gains and is trading around the 0.8350 mark.

Sterling is being led higher by a rise in UK Gilt yields; the 2-year yield immediately jumped 15 basis points on the news, but has since fallen back slightly to 1.38 per cent. Although some investment houses have revised their outlook for UK rate rises and now expect hikes to come in the third quarter of 2011, previously their forecasts were for rates to rise in the first quarter of 2012, it is far from certain that the Bank of England will hike rates. The Bank kept rates on hold during its meeting last week, will have seen today's CPI data before they made their decision. This makes the minutes from the meeting, released on 26 January, all the more interesting. With inflation fast approaching 4 per cent and commodity prices still rising, it will be interesting to see if there is a more hawkish bias amongst the committee. Right now the prospect of the UK raising interest rates before the US is fuelling GBPUSD strength.

Europe's Finance Ministers meet today to discuss plans to find a more permanent resolution to the sovereign debt crisis. So far the news flow out of Europe has been mixed. There was good news for Spain after its long-term debt auction scheduled for this week attracted large demand from global sovereign wealth funds. Its auction of shorter-term 18-month bills this morning was also well received and yields were lower at 3.367 per cent vs. 3.721 per cent at its auction in December. However, there are contrasting opinions within the Eurozone's leadership about how quick the currency bloc needs to act to find a permanent solution to the sovereign debt crisis. While some countries would like to see the European rescue fund immediately doubled and given powers to directly purchase the bonds of members in financial trouble, Germany is holding off. In fact Germany's Finance Minister Wolfgang Schaeuble explicitly said that the recent calm in financial bond markets and drop in peripheral nations' bond yields to below critical levels removes the urgency to act immediately. Germany is not in favour of expanding the fund, and one can expect that today's meeting will not reach any conclusions.

This will only push the can down the road. It appears that the market will have to push the European authorities into taking decisive action, but right now there is little appetite to do so from the most powerful Eurozone members. This hasn't hurt the euro too much. It is hovering around the 1.3400 level, after reaching a low of 1.3255 yesterday, which is now good support. The market may be disappointed by the lack of a unified message and definite commitment to sort out the sovereign debt crisis once and for all. For now European assets are not getting punished for this, but investors could turn at any moment, and Portuguese bond yields have started to rise again, they are currently 6.97 percent, within touching distance of the critical 7 per cent level.

A strong reading in Germany's ZEW index has fuelled broad-based gains for the single currency during Europe's morning session. Investor confidence in Europe's largest nation is at a 6-month high after rising from 4.3 in December to 15.4 in January, investors had been looking for a rise to 7. This reinforces the two-speed economic recovery in Europe, with Germany acting like a emerging market and weaker nations still suffering. The ECB will have to navigate a difficult path in the coming months to set policy for the benefit all members that are growing at different speeds.

Elsewhere, AUDUSD is trading within reach of parity at 0.9980, even though expectations are for the flooding in Queensland to shave nearly 1 per cent off GDP growth in the first quarter. If the flooding spreads to Victoria as expected then it might be difficult for the Aussie to sustain its recent gains.

The US is back to work today after yesterday's public holiday. Empire Manufacturing and housing data are the highlights of the economic calendar. But some high profile earnings should be more exciting. Citigroup announces results at 1300 GMT/0800 ET; the market is expecting a $0.07 gain in the fourth quarter of 2010. Apple will release results after the US markets close at 2200 GMT/ 1700 ET. Although results are expected to be stellar due to bumper sales of iPads during the holiday season, news that Apple CEO Steve Jobs has taken an indefinite leave of absence for health reasons should weigh on the stock. Since Apple makes up 20 per cent of the Nasdaq, it could also come under pressure in trading later today. Canada is also expected to leave interest rates on hold at 1400 GMT.

Data watch:
EU Euro money Central and Eastern Europe Forum in Vienna
13.30 GMT (0830 ET) US Empire Manufacturing Index Last 10.57 Exp 13.0
14.00 GMT (0900 ET) US TIC Data Last 27.6 Bio Exp 40.0 Bio
14.00 GMT (0900 ET) Canada BOC Interest rate decision Last 1.0 Exp 1.0
14.00 GMT (0900 ET) EU Noyer speaking
15.00 GMT (1000 ET) US NAHB Housing market index Last 16 Exp 17
23.50 GMT (1850 ET) JP Tertiary Industry Index Last 0.5 Exp 0.5%

Best Regards,

Kathleen Brooks| Research Director UK EMEA |
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