Tuesday 17th February 2009

The Euro finally breaks down through the 1.2700 support …..

…. which had held since early December. The target going forward is now for a lower rate with the medium term outlook still towards 1.1500. This latest Euro weakness stemmed from renewed apprehension towards the economic outlook for Eastern Europe and a warning released by Moody’s overnight that Western European Banks’ rating would need to be downgraded as a result. The largest exposures to Eastern Europe are carried by Banks from Austria and Sweden but significant loans are also carried by German, French, Belgian and Italian institutions, which combined, account for 84% of western European lending to the region. This provoked a new wave of risk aversion trading this morning in Asia with weakness seen not only in the Euro but also the AUD, NZD and other regional currencies. The Yen, which has been a safe haven since the demise of the carry trade mentality, didn’t benefit either as their own domestic woes appear finally to be catching Japan up (ie the collapse in Japanese economic activity - down nearly 13% y/y, the move to a deficit on trade and rising political risk with the PM’s approval rating falling below 10% and the untimely departure of the Finance Minister following his ‘Rome adventure’).The currency didn’t fall however and whether it was on the back of suspected US$ bond redemptions or whether Market perception that we are going to have ultra-low global interest rates for some time to come (hence no renewal of carry trade) or a combination of both doesn’t matter. The fact is that any weakening of the Yen might prove to be some time away.

No data yesterday combined with the US holiday left us grasping for official comment and the officials didn’t disappoint. The usual ECB rhetoric emerged with various members talking in a concerned way about the European economic situation and implying interest rate cuts to come. The BoE Deputy Governor, Charles Bean, speaking at the National Union of Farmers Conference in Birmingham predicted that there was a 75% chance that the UK economy would contract by more than the 4% rate that was predicted by Mervyn King last week. This comes amidst rising fears that data is about to show the UK entering a period of deflation. Today’s release is expected to show that the RPI year-on-year figure has dropped to, or just below zero (expected to be -0.1%) and the CPI number, although less dramatic, will still show an easing from 3.1% down to 2.9%. This maintains the probability that the Government’s target rate of 2% will be reached/breeched in the figures for March.

In Europe, today’s German ZEW survey will confirm the severity of the recession in the Eurozone. Think of a number and put a minus sign in front of it - you won’t be far wrong.

Not much else on the release front. US TIC data will be watched for confirmation that Foreign Investors are still ploughing money into US investments.

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