Whilst recent UK economic data has been extremely positive yesterday this trend was broken. Overnight GfK Consumer Confidence fell by more than expected to -22 (consensus -20, previous -19). This follows yesterday’s news that house prices fell by more than expected in July, coming in at -0.5% m/m (consensus -0.3%, previous 0%).

It appears that concerns about the medium-term impact of fiscal austerity measures on personal finances is outweighing any potential optimism about the recent recovery’s momentum, thus keeping demand low.

In other data, both mortgage approvals and mortgage lending in June fell more than expected and M4 money supply was unchanged for June.

Despite this negative development, Sterling continued its recent surge against the US Dollar and managed to close at levels not seen since February of this year.

Significantly, sterling is well supported ahead of a key technical level, the 200 day moving average of 1.5543.

The Governor of the Bank of England, Mervin King, warned yesterday that a continued economic recovery was still unsure and that inflation is likely to remain above the 2% target for the next year.  King delivered a rather frank message to banks saying that their harsh treatment of corporate clients was leading to a “heartbreaking” situation in Britain’s small and medium sized business sector.

He said “It is a very tough job to build up these businesses and I do think that we need a pattern of finance that respects the need for these longer-term relationships.”

Mervyn added “They [small and medium-sized companies] may have had the same banking relationship for 60, 80 years and then suddenly out of the blue, comes a letter churned out by a computer which says that the terms of our relationship have changed.”

The bearish comments tempered Sterling slightly but that didn’t stop the Great British Pound hitting a fresh 5 month high against the USD following recent robust economic indicators and we are now trading at 1.5639 on cable.

Sterling received another boost this morning after a leading think tank announced that Britain will avoid a double dip recession and its economy will expand at trend growth rates as early as 2012. In the latest forecast from the National Institute for Economic and Social Research (Niesr), it predicts GDP growth of 1.3% this year, 1.7% next year and 2.2% in 2012.

The news follows recent strong economic data over the past week where GDP and retail sales figures shocked the market on the upside.

The pound has surged to 5 month highs against the dollar and the general consensus is Sterling will continue on a long term rise against the Greenback.

Merv “the swerve” King will be speaking today and as usual, I’d expect “doom and gloom” comments from the BoE chief.

Most likely on his radar will be the GDP figures from Q2 which showed a rise of 1.1% QoQ (0.6% forecast).

One in fifth of the 7.66 trillion yuan (1.1 trillion dollars) that Chinese banks lent to local governments is “at serious risk of default”, is the latest potential default risk problem to halt the global recovery. Chinese banks lent vast sums of capital to local Chinese governments for construction projects after Beijing called for nationwide efforts to stimulate the economy.

However, only one quarter of projects financed by the loans have the ability to meet repayments, according to the Century Weekly.

The banking regulators, along with the banks that have the biggest exposure, will carry out detailed discussions with local governments starting in September about how to recoup the loans, the report said.

China has powered out of the global crisis on the back of a stimulus package worth four trillion yuan and the state-backed bank lending, which saw new loans nearly double from the previous year to 9.6 trillion yuan in 2009.

This latest potential default raised concerns in Beijing over a possible new crop of bad loans that could threaten the world’s third-largest economy.

The results of the Eurozone bank stress tests were eventually released on Friday evening showing only 7 of the 91 banks tested were deemed to have failed, and the capital shortfall was estimated at €3.5 bn. Both are very much at the lower end of consensus forecasts, raising questions over the credibility of the tests. Interestingly, a sovereign default or restructuring scenario was not included, as media leaks earlier in the week had suggested.

At the press conference, ECB Governing Council Member Constancio justified this decision by noting that “instruments have been put in place precisely to avoid that scenario”. Nevertheless, as the leaks had suggested, many participating banks voluntarily disclosed their sovereign debt holdings, and this has brought some improved transparency on sovereign debt exposure.

This seems to have averted any euro selling pressures as the single currency continues to trades close to Friday’s 1.29 range against the dollar.

From a data perspective, the euro had already managed to move higher on Friday morning after stronger than expected German business sentiment data. The German IFO business confidence index recorded its strongest rise for 20 years in July.

The closely watched index rose to 106.2 points from 101.8 in June. Germany’s economy shrank by almost 5% last year, but has been recovering due to strong exports. The result was much better than expected, with most economists having expected a slight fall.

Sterling has just received a welcome boost after the release of positive retail sales figures.Data showed a 0.7% increase month-on-month & 1.3% yoy, the highest monthly figure since April 2008.

The ONS suggested the World Cup boosted consumption of electrical goods, which after England’s performance should see a double whammy when people look to replace the TV’s thrown out of the window after the Germany game.

Bank of England minutes released showed a 7-1 vote in favour on keeping interest rates on hold, with Andrew Sentence, the only dissenter, voting for a rate rise. More interestingly, the minutes showed discussion of an extension to the asset purchase scheme if, as expected, the economic outlook continued to deteriorate.

Sterling continues its recent volatility in light of the comments & also rumour circulating yesterday that the bank has reopened dollar swap lines and low liquidity in the market exaggerates moves.

The Euro continues to tread water ahead of the Stress test results. There is increasing uncertainty around the release of the results, the planned announcement is today at 4.30pm.

Strange that an exercise in reducing uncertainty and restoring credibility is actually having the opposite effect, and that is feeding though to the Euro which now trades lower against both Sterling and the Dollar.

The perceived safe haven of the Swiss Franc has also hit the headlines as the SNB announced a huge FX loss following large bouts of currency intervention earlier in the year. The continuing strength of the Swissy will be a real headache for the central bank as it fights to remain out of a potential deflationary spiral brewing in the Eurozone.

Last night Ben Bernanke, Chairman of the Federal Reserve, delivered his twice yearly report to Congress where he outlined their outlook on the US economy.
Due to the oblique nature of Central Bank parlance, Mr Bernanke’s speech was closely watched for any indication, however vague, that the Fed thinks the economic recovery in the US is not proceeding the pace originally thought.

He duly obliged, saying that the outlook was “unusually uncertain” and stressing again that persistently high unemployment remains a real problem and is likely to remain so for an extended period.

The dovish tone and increasingly cautious outlook naturally led to a reduction in risk appetite and the corresponding sell off in US equities and rise in the Dollar.

Cable had a volatile days trading yesterday, just before 8am we saw a huge Sterling sell, dropping from 1.5290 to 1.5168 in a minute before recovering after reports of a fat finger or algorithmic trading problem at a bank in the Netherlands.

Whatever happened, we are sure someone is seeking alternative employment this morning.

This week is all about the euro and the approaching stress test results which will offer much needed feedback on the health of European banks.
The euro has experienced a significant turn of fortune from its June 4 and half low against the USD gaining over 10 cents to test the 1.30 level.

One reason that the euro has gained is simply that the market was significantly over short in the euro and naturally a lot of these short investors paired their positions leading to a short squeeze higher.

In addition some comfort has come back into the euro approaching Fridays stress test results as comments in the run up from members of the IMF and the ECB have been bullish – we will see!

Recent gains have led to EUR/USD testing the 1.30 level and GBP/EUR falling back into 1.17 territory. The results are due out from 5pm GMT on Friday- good feedback should push EUR/USD over 1.30.

The Euro rose significantly yesterday rising up to 1.2991 against the dollar and breaking, although briefly 1.30, a ten week high.The gains were owed to more weak data from the US where home-builder sentiment fell more than expected in July to the lowest level in over a year and comments from many of the EU countries stating their most important banks had passed the stress tests.

Germany, whose sources said Deutsche Bank and Commerzbank passed the tests look set to see Hypo Real Estate, a small nationalised mortgage lender fail, and it could be the first of many banks who specify in that market.

With the housing market across Europe still struggling, banks who exclusively work in that sector could have overly exposed balance sheets and be the next to require a takeover or even a bailout.

The Euro has also gained massively against Sterling falling well back from the high of 1.2380 3 weeks ago to 1.1750.

The BoE will be releasing the MPC Meeting minutes from the July rate decision tomorrow where we will find out more details to the divide growing in the committee.

Record price cutting in the Summer sales on the high street and falling petrol sales helped to push down inflation to its lowest rate since December.
The annual Consumer Prices Index inflation rate fell from 3.4 per cent to 3.2 per cent in June, the Office for National Statistics said.

Clothing and footwear prices fell by 2.1 per cent – the biggest reduction seen in June since the ONS began collecting monthly figures 14 years ago.

Petrol prices fell by an average 2.6p a litre to 117.9p – in contrast with a 4.4p hike a year earlier – dragging down the rate of inflation.

The ONS said clothing sales were more widespread this year, particularly for categories such as womenswear.

Offsetting this were other factors such as the soaring cost of air fares – ticket prices to South Africa doubled for the World Cup – as well as higher insurance premiums.

The figures also showed a rise in “core” inflation – excluding volatile factors such as food and petrol – over the month from 2.9 per cent to 3.1 per cent.

The CPI rate of inflation remains well above the Monetary Policy Committee’s 2 per cent target and has stayed at 3 per cent or higher throughout this year.

The Bank has already predicted that CPI will gradually fall back later this year as the economic slack built up by a record recession drags down prices.

The committee has left monetary policy unchanged since last November, with interest rates at a record low of 0.5 per cent.

The retail price inflation measure – which includes mortgages costs – fell less than expected to 5 per cent from 5.1 per cent.

Factory gate prices from manufacturers fell last month for the first time since November 2008.