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The EURO remains weak due to the tense situation in Spain and Italy

The EURO remains weak due to the tense situation in Spain and Italy

The eurozone debt crisis rumbles onwards. Spanish yields edged higher after a disappointing government debt auction yesterday. 10-year yields are back at 6.834, marking a new post-euro high. Italian borrowing costs rose back above 7%. British PM Cameron visits Van Rompuy in Brussels and then Chancellor Merkel in Berlin. He is expected to support Merkel‟s demands for limited changes to the European Treaty as long as the UK keeps its opt-out on joining the single currency and other related integration measures. He is also expected to reject German demands for a financial transaction tax, arguing that without a global agreement, it will harm London as a financial centre.

So the stock market sell-off is set to continue today, helped in part by comments from ECB President Draghi. Speaking this morning, he noted that the „downside risks to the economic outlook have increased‟ which we suspect signals a rate cut in December on the back of markedly weaker ECB staff forecasts for both growth and inflation. They also noted that the despite passing legislation to implement the EFSF four weeks ago, governments have yet to increase its leverage as agreed. Draghi‟s swipe at eurozone member governments could signal ECB reluctance to intervene in secondary debt markets while governments fail to fulfil their part.

With equity markets falling, we would expect to see a rally in bond markets due to risk aversion. That pattern may still continue, but peripheral bond yields are likely to see renewed upward pressure should the market question the ECB‟s commitment to bond purchases.

Sterling-Euro- traded within a narrow range around 1.170. Sterling managed a small rally yesterday after stronger than expected October retail sales data, but with retailers openly questioning the 0.6% outturn as wildly overoptimistic, sterling will struggle for direction. The dovish November Inflation Report suggests that the MPC will extend Quantitative Easing beyond February 2012, which should weaken sterling further, even if market participants remain sceptical as to how exactly gilt purchases will support the broader economy.

The only US release of significance today is the index of Leading indicators for October. The market is looking for a 0.6% rise.

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