The fact that CPI has remained steady will slightly ease the pressure on the ECB to cut interest rates in their March meeting. In the forex markets the theme of the week for most currency pairs has been range bound trading.

EUR/USD looks the most likely to break its current range as it approaches 1.26, GBP/USD is also approaching support at 1.4150 and GBP/EUR is being buoyed by USD strength against EUR.

Over the last week we have continued to see the YEN unwinding particularly against the USD falling 9% from the low to high point in the week- a major shift in sentiment!

This is not surprising after a poor start to 2009 for the Japanese economy; figures demonstrated that exports fell 46% in January alone and their economy sank 3.3% in the last 3 months of 2008. This weak data was exasperated by the resignation of the Japanese finance minister Shoichi Nakagawa following his erratic performance at the recent G7 meeting.

The weakening of the Yen as discussed earlier this week underlines a shift in sentiment away from a currency previously conceived as a “safe haven”.

The trend of the “Dollar Index” which tracks the US currency against a basket of currencies demonstrated this movement away from Yen and back into the dollar. The index has already increased 8% in 2009 as investors are now looking at the US dollar as the favourable option for safety.

This is ironic given the awful data arising from the US economy…. yesterday we saw durable goods fall 5.2% in January and jobless claims soared to 667,000- very weak data which only helped to strengthen the dollar as risk aversion and a flight to safety stepped up a notch.

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This illusion was shattered by dovish comments from MPC member Blanchflower and the news that RBS announced the biggest loss in corporate history at £24.1 bn; this was attributed by Chairman Philip Hampton to “unprecedented turbulence” in the finance markets.

The Pound shed 4 cents against the dollar and 2 cents against the euro; the situation was not helped with continued weakness in the equity markets which encouraged the safe haven dollar to be bought.

The scale of the loss for RBS was expected by the markets and the fall in Sterling was mainly attributed to comments by MPC member Blanchflower, who stated that unemployment is in line to rise by 60,000 every month.

Bank of England governor Mervyn King is due to discuss the banking crisis before the select committee on Thursday; this could increase calls for quantitative easing to commence in order to increase money supply.

This strategy will be a gamble for the economy as it is considered an unconventional measure, therefore it will be interesting to see how this unfolds and whether this will increase money supply or simply cause the banks to hoard more funds. If introduced there will pressure on the banks to increase lending- this time more conservatively!

In terms of economic data, today we have seen Nationwide UK house prices slump 1.8% in February- a record drop. This equates to a year on year fall of 17.6% and raises the probability that house prices could face further declines throughout 2009.

The continuing fall in house prices obviously has a direct link to mortgage lending, although lending increased in December it was still £5.8bn below the previous year with mortgage approvals in December less than half of the previous year.

The ideal goal for the government will be to increase lending and liquidity with the relevant controls in place so we do not see a repeat of this downturn; a long term goal in all probability.

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He again highlighted that the US economy still faces further contraction, however he intimated that the US government would not move to nationalize US banks as this would lose value already built into banks. On the back of this there was an expected jump in bank stocks and this was the main driver for the gain in the Dow.

President Obama addressed congress for the first time yesterday and again stressed the severity of the economic crisis; he vowed to put a stop to wasteful spending and vowed that banks and bankers taking public funds would be held accountable.

He also reaffirmed his plan to cut the spiraling deficit which is becoming a huge problem for the US economy and will weigh on the dollar if not significantly reduced. Overall his address offered hope and determination for recovery as he vowed “we will build, we will recover”, lets hope so!

Yesterday in Europe we saw the German Ifo survey come more or less in line with expectations, today saw GDP come in exactly as expected at -2.1%. In the UK 4th quarter GDP was actually a touch better than expected showing a contraction of 1.5%, however taken in context this brings the year on year to -1.9% which is an 18 year low and reinforces the sharpness of the slowdown.

Following yesterdays theme on the Yen we have seen further weakness for the Japanese currency. USD/YEN has now reached 97 and GBP/YEN is back over 140 as the retreat from the Yen as a safe haven continues.

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Investors responded to fears that the world’s largest economy is sinking further into recession and speculation that the US Government may be forced to buy stakes in ailing banks, despite assurances from Washington that lenders would not be nationalised.

Japan’s Nikkei Index fell by 1.5 per cent to a four-month low, narrowly avoiding a slide to below 7,000 for the first time in 26 years, closing at 7,268.56. In Hong Kong, the Hang Seng lost 461.46 points, or 3.5 per cent, to end the day at 12,713.64. Last night, the Dow Jones industrial average fell to an 11-year low, losing 250.89 points to 7,114.78.

Japanese shares remained in the red for the day despite hints from Kaoru Yosano, the newly appointed Finance Minister, that the Government may be working on more measures to support the domestic share market.

“The side-effects of falling stock prices are worse than expected,” said Mr Yosano. “We are witnessing many negative wealth effects with impaired assets held by banks and insurance firms.”

Japan’s Government is understood to be mulling over plans to buy falling stocks with money from the public purse in an effort to keep prices buoyant.
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Japan’s biggest securities house, Nomura, announced that it planned to raise about $3.1 billion via equity issuance. The capital-boosting scheme – itself seen as a sign of deepening trouble in Japan’s financial sector – is expected to cause massive dilution for existing shareholders, a risk that sent Nomura’s shares down 8.4 per cent.

Concern is growing that the Japanese banks, despite their stable capital position relative to peers in the US, will rein-in their spending even more fiercely, triggering bankruptcies throughout the small and medium-sized industrial heartlands of Japan.

“The view out of the porthole has become rather watery,” said one Mitsubishi Tokyo UFJ broker describing the four-session run of selling in Japan.

The broader investment scene in Japan was no more cheerful. There have been ten bankruptcies among Tokyo-listed companies so far this year and the cost of insuring Japanese corporate debt against default has now near a record high.

On currency markets, the yen fell to a one-month low amid warnings by analysts that the recent strength of the Japanese currency was wildly out of kilter with the country’s economic strength and that the speculative use of the yen as a “safe haven” would now start to decline.

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What we did see was more negativity in the equity markets as the Dow fell to the 2002 lows below 7300 amid fears that the US government will raise their stake in Citigroup and Bank of America- a step closer to nationalization which has raised concern for investors.

On the back of this the USD is showing the strain and we have seen a move higher on GBP/USD and EUR/USD reversing the dollar strength we saw last week.

Looking to the week ahead the main data to look out for will focus on releases from Europe and the US. Tomorrow we have the German IFO survey and Wednesday we see GDP data from Germany- the IFO survey will give an early indicator of current business expectations and sentiment and Wednesdays GDP will give a statistical measure of German economic activity and health.

The Yen over the last few months has been a dominant force in the fx markets. With risk aversion coming to the fore the yen has strengthened dramatically with a 43% gain on the pound and 14% on the dollar.

However over the last week there has been a shift in sentiment on the Yen with a growing feeling that going forward the Yen may not be the best option as a safe haven currency- with GDP contracting sharply and the resignation of their finance minister Shoichi Nakagawa.

It will be very interesting to see how this scenario plays out as this will re-distribute the flow of funds to other currencies. Other safe haven favourites being the USD and the Swiss Franc, the effects of any redistribution could have a major impact on the currency markets…

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Data just released from Germany shows that the service sector has declined at a rapid pace and manufacturing activity also dipped slightly, this data emphasizes that there is little prospect to a near term end to the contraction.

EUR/USD yesterday made a recovery back to 1.2760 before retreating back to 1.26…the important factor is that it has not dropped below the 1.25 support level.

No real break in trend yesterday for the pound as it continued in a choppy range against the USD and the EUR. We have just seen retail sales data from the UK which is a surprisingly good number- showing a rise of 0.7% against the consensus of a fall of 0.1%.

The unexpected rise has been attributed to an increase in internet purchases and aggressive price cuts by retailers- in the immediate aftermath sterling moved higher against the USD and EUR.

In the US Barack Obama will host a summit next week to tackle the spiraling US deficit which is looking at levels of over a trillion dollars every year for the next decade. Obama is looking to revise a strategy to reduce the deficit over the next 10 years- if a plan is not put into place soon then this ballooning deficit should start to weigh on the USD especially if the equity markets start to recover.

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Britain’s public sector net debt is already a record high, hitting 47.8 per cent of GDP in January, official figures show. This is the highest level of debt recorded since the ONS started recording data in 1993.

The ONS said that it had decided to add the banks to the labour Government’s books because “the Government has the ability to control the respective banks’ general corporate policy through the conditions associated with the agreements signed relating to recapitalisation.”

Howard Archer, of IHS Global Insight, the economic consultancy, said: “Given the rate at which the UK public finances are deteriorating and new measures are having to be introduced to try to support the financial sector and the economy, it is frankly anyone’s guess as to how high the public deficits may go over the next couple of years.”

The massive debt will cause problems for the labour Government, which has already seen Northern Rock’s debts added to its accounts. Analysts said that it would probably have to revise up its borrowing forecasts in April’s budget.

Andrew Goodwin, Senior Economic Adviser to the Ernst & Young ITEM Club, said: “We expect the Chancellor to be forced to make significant upward revisions to his borrowing projections when he presents the Budget.”

The public sector showed a surplus on current budget of £8.4 billion in January 2009, compared with a surplus of £15.3 billion in January 2008.

Between April 2008 and January 2009, the public sector recorded a deficit of £42.5 billion. At the same stage of the 2007-08 financial year, a deficit of £7.0 billion had been recorded.

Mr Archer said: “The public finances for January are terrible, coming in even worse than feared. January always sees a surplus on the public finances at is a bumper month for tax receipts.

“Unfortunately though, bumper hardly describes the tax receipts for this January as they have been decimated by sharply contracting economic activity, declining profitability, rising unemployment, reduced bonus payments, December’s VAT cut and substantially weakened housing market activity and prices.

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The 3.0% level is still well above the Bank Of England’s 2% target for inflation and this data suggests that interest rates may not need to be cut in March as previously thought.

However inflation will remain a concern for the Bank Of England- Mervyn King has already signaled that inflation could fall sharply this year and todays BOE minutes will give us more insight to the sentiment of the MPC.

The euro was the big loser in the currency markets yesterday falling to 2 month lows against the dollar and also retreating against the pound…real concern is now prevalent on the health of eastern European banks.

With the threat of a downgrade in credit looming over eastern European subsidiaries of Swedish and Austrian banks coupled with the expectation of more banking losses in Europe forcing the euro lower.

The EUR/USD moved to a low of 1.2548 and 1.25 is now the key target before a break to 1.2312…GBP/EUR failed to hold above a move back to 1.13 yesterday, however this will again become the target as the spotlight remains on the euro and its woes.

Overnight the final approval was placed on the US stimulus package of $787bn which is desperately hoped will kick start the global economy. The urgency of Obama to introduce this stimulus was justified as General Motors and Chrysler have requested another $21.6bn on top of the $17.4bn already received.

This caused a sharp sell off in equities- in particular the Dow as risk aversion kicked in.

One to watch in the markets at the moment is USD/CAD which has broken a key resistance level of 1.26…with risk aversion and the falling value of Oil we could see this pair re-test the 1.30 level in the near term.

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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.

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.

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The Bank last week predicted a near 4 per cent year-on-year fall in output as the credit crunch tightens its grip on the wider economy.

But Charles Bean told an audience in Birmingham there was “roughly a three in four” chance of growth even weaker than the Bank’s already-gloomy central projections.

Lingering woes in the banking sector and nations shunning free trade in favour of protecting their own industries could hinder a recovery, according to Mr Bean.

He told the National Farmers Union: “It is possible that efforts to restore the banking system may take longer to bear fruit, and that the adoption of protectionist measures abroad as the downturn deepens may slow the recovery.”

The deputy Governor admitted that a “failure of imagination” had been in part to blame for the wider economic carnage caused by a debt-driven boom in property and asset prices.

He said “no one really foresaw the virulence with which the crisis would unfold”, but argued that keeping interest rates at a higher level between 2004 and 2007 “would just have implied markedly higher growth and higher unemployment at an earlier stage”.

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