Yesterday saw the world’s main central banks announce joint action to provide US Dollar liquidity, aimed at securing the funding needs of euro banks struggling to meet american funding requirements.  The money markets had been showing signs of stress, with several measures at their highest level since the financial crisis.

The loans will have three month maturities in contrast to the normal one week limit in central bank market operations so banks are given time in the run up to the end of the year to finish window dressing their results without worrying about funding issues.

The news gave a boost to the Euro against the Dollar, rising almost 2 cents in the course of the afternoon before falling back in the overnight Asian session.

The announcement was also good if you own bank shares, which clawed back recent losses especially if you bought the French lenders after their recent crashes.

More than £4 billion was wiped off UBS shares, however, as losses of $2 billion were uncovered stemming from trades put on by rogue trader in their London office.

The bank has not announced where the losses were made, but there is speculation that it could have stemmed from trades in the Swiss Franc which moved over 10 cents in a matter of minutes after the SNB announced it was pegging the currency to the Euro.

Have UBS not announced where the losses were made because of the potential embarrassment of a Swiss bank losing money as a direct result of the SNB intervention?

What the news has done is presented an open goal to all of the advocates of the ICB report on the ring fencing of retail banks from the “casino” investment banking side.

The timing was impeccable, not only was the fraud uncovered 3 years to the day of the Lehman bankruptcy, but it came in the same week as the report was published.

Currency exchange money markets continue to dither between the US debt ceiling issue and eurozone peripheral debt worries.In spite of a lack of agreement to raise the debt ceiling, with House Republicans failing to back a bid by House speak Boehner, the Greenback in fact strengthened towards the end of last week as eurozone peripheral issues came back under scrutiny.

The strength of the Dollar to the lack of progress in raising the debt ceiling is remarkable and exposes the single European currency even uglier than the US Dollar, in many investors’ eyes.

The key drivers for the week ahead will depend on the scale of any boost in the debt ceiling and additional budget deficit reduction methods.

If a deal is reached ahead of the August 2 deadline it is not clear that the Dollar and risk currencies will enjoy a rally unless the debt ceiling deal is a solid and major one.

Given the limited market follow through, following the recent deal to provide Greece with a second bailout, the EUR remains wholly unable to capitalise on the USD’s woes.

A reminder that all is not well was the fact that Moody’s ratings agency placed Spain’s credit ratings on review for possible downgrade while reports that the Spanish parliament will be dissolved on September 26 for early elections on November 20 will hardly help attitude for the EUR.

Compounding the Spanish news doubts that the EFSF bailout fund will be ready to lend to Greece by the next tranche deadline in mid-September and whether Spain and Italy will participate, have grown.

The potential danger for the USD this week is not only that there is disappointing result to the debt ceiling discussions, but also that there is a weak outcome to the US July jobs report.

An increase of around 100k in payrolls, with the unemployment rate remaining at 9.2%, will fixate market attention on weak growth and if this increases expectations for a fresh round of Fed asset purchases the USD could be left rather vulnerable.

So far today we have had UK CPI manufacturing which came in at a disappointing 49.1 down from revised 51.4 in June and some way below median forecast of 51.0.

Sterling now currently sits at 1.6417 from a high of 1.6475 and 1.1390 against the Euro from a high of 1.1450….bad start to the week for the Pound.

As much as European bankers try to stop it, contagion appears to be spreading through the Eurozone with Italy’s high debt burden and lack of political will leading to more emergency meetings.  Reports that their debt stands at double Greece, Ireland and Portugal combined led to equity markets slumping and bond spreads jumping.

Europe signed a treaty to establish a permanent €700bn bailout fund, but this is only available from 2013.

In the meantime, a second bailout for Greece is still being agreed with the hope this will shield Italy.

Last night, Moody’s downgraded Ireland into the junk territory saying “it is likely that, like Greece and Portugal, Dublin will need another bailout before it can return to the markets.

Meanwhile, the UK received some unexpected news with a fall in inflation; the first negative number for June since 2003.

The figures showed CPI inflation rising by 4.2% against expectations of 4.5%.

This gave a mixed view for the UK economy as on the positive side, it shows the huge rise in inflation potentially starting to tail off and drop towards the target level.

Unfortunately, the main reason for things becoming cheaper is retailers having to slash prices to entice the public to spend what little cash they have.

Overall, Sterling was pretty steady after these figures and moves were mostly as a by product of massive swings in Eurodollar.

The volatility has continued today as the uncertainty surrounding many of the worlds markets has left traders and investors with massively diverging opinions.

It seems to be “watch this space” at the moment while we wait for more news out of Europe.

The credit rating agency Moody’s has downgraded Portugal’s long term government bond rating to junk- this has heightened fears that only eight weeks after their first bailout Portugal may need further help in meeting its debt obligations.This has rattled the euro which was recovering nicely against the US Dollar following the recent Greek fears- it also emphasises that the rot does not stop with Greece.

The Euro has lost over a cent against the US Dollar and has lost against all but two of 16 major currency peers.

The hard line taken by Moody’s in downgrading Portuguese debt by 4 notches sends a message to the markets that the ECB and the EU still have significant work to do and that their methods may not align with the credit rating agencies- a concern for the markets and the euro.

The ECB is expected to raise interest rates tomorrow which will have helped support the Euro even in the light of other issues- but quite how the PIGS will react is an open question.

The ECB is expected to raise rates by 25 basis points to 1.5% even in the light of slowing economic growth- a policy that is currently the opposite of the UK and the US.

However at the moment the euro is on the back foot and any more feedback from ratings agencies could pile on the pressure.

Over to the UK and the Pound has managed to claw back some of its losses against the euro- this is  mainly due to euro weakness as explained above.

Against the US Dollar the Pound is down- this is due to risk aversion which is US Dollar positive and again due to the Moody’s downgrade of Portuguese debt.

Data from the UK showed that UK shop price inflation increased sharply and a survey by KPMG-REC identified a slowdown in fulltime jobs growth.

However the Pound has been largely unaffected by this data- tomorrow we have the Bank Of England interest rate decision and it is expected that no change will be on the cards.

Asian currencies are stronger following of a spike in risk appetite after the agreement on Greece’s austerity measures.The rise in Asian money markets are revealed in the ADXY (an index of Asian currencies) index which is approaching a test of its 2nd May high around 119.26 around its highest level since August 1997.

Technical levels have turned more positive, with the ADXY breaking above its key moving average levels and the 14-day relative strength index also turning higher.

The Asian rallies have been led by the South Korean Won (KRW), the Asian currency that has had the strongest link with risk over the past few weeks.

Given that risk aversion has dropped sharply since mid June it is no surprise that this currency has strengthened the most.

USD/KRW is trading around its lowest level since August 2008.

Strong equity capital outflows had kept the KRW on the back foot over much of June but there has been a bounce back in flows recently.

However, USD/KRW is likely to find it tough to break below 1060 over the short-term, especially given likely resistance from the local authorities.

The Thai Bhat (THB), the worst performing Asian currency in June, has rapidly reversed some of its losses.

The THB looks set to consolidate its gains following a decisive election result which saw the opposition Puea Thai Party gain control of parliament.

The biggest relief for markets was the fact that the outcome was relatively clear cut, suggesting a potentially a smooth handover of power.

Nonetheless, the currency has already jumped and after having dropped to around 30.40 from a high of around 31.01 USD/THB is likely to trade off gyrations in risk appetite.

The fact that the Greenback has lost some ground in the wake of firmer risk appetite and better news in Greece has also allowed Asian currencies to strengthen.

In other words, although USD weakness has helped to facilitate Asian currency strength, the recent strengthening in Asian FX is more likely to have been due to a rebound in capital inflows to the region.

The Greenback lost some ground as risk appetite increased but markets remain lively as attitude switches between ‘risk on’ and ‘risk off’.As US Q1 GDP was left unchanged as jobless claims astonishingly increased together with continuing Greece worries suggests that a risk off mood may filter into markets despite positive US earnings.

Although the USD has not particularly benefited from any rise in risk aversion lately, worries about the next IMF tranche being withheld from Greece will likely play more positively for the USD.

Nonetheless, lurking in the background and helping to keep the USD restrained is the Fed’s ongoing asset purchases as QE2 remains in place until the end of June.

Moreover US data disappointment points to risks that the Fed will only slowly embark on its exit strategy.

Additionally any agreement towards extending the US debt ceiling appears to be far off, and threatens to go down to the wire all the way to August 2.

US debt markets and the USD appear to be downplaying this issue at present but it remains a clear threat to US markets.

Continuing to limit any upside in the EUR is the fact that officials and markets continue to gyrate on whether Greece will or will not restructure its debt.

Apparent divisions between the view of some officials and the ECB are adding to the confusion whilst fresh worries about the IMF withholding funding for Greece will likely keep EUR/USD capped.

The probability of further ECB interest rate rises in the near term increased yesterday as the eurozone recorded another slight increase in the core cost of living index.
Given the hawkish tones (although they were slightly less so at the last meeting) of the ECB, one would expect the euro to respond positively to the prospect of higher rates, but sentiment remains weak in light of a continuing story regarding the head of the IMF, Dominique Strauss-Kahn, and its potential impact on the ongoing sovereign debt issues.

Mr Strauss-Kahn was refused bail and will remain in custody until his next hearing on the 20th May.

In his absence EU financial ministers did manage to approve the £65 Billion bail out of Portugal, the IMF providing around one third of the funds (the other two-thirds are from the 2 bail-out vehicles set up by the EU).

Over in the US President Obama again called for Congress to approve increasing the debt ceiling to avoid what he described as a potential “devastating economic and financial crisis”.

Republicans are aiming for guarantees on deficit reduction before they agree to a hike in the debt ceiling and the inertia is beginning to worry the markets, given the estimated day that the government runs out of money is the 2nd of August.

The Federal Reserve minutes from their last meeting are due today at 6pm, as ever the markets will be looking for comments on the economic recovery (especially on housing and the labour market) and anything regarding the end of QE2 and the Fed’s strategy once the easing has ended.

As Wise Money mentioned yesterday, the big news for Sterling this week looked set to be the Bank of England Quarterly Inflation report- and so it turned out to be. The Bank had to adjust growth projections downwards and suggested inflation will stay above target until at least 2013.

The key point for Sterling, at least for yesterday, was that the Governor hinted that interest rates will begin to rise towards the end of the year.

The latter seemed to dominate the former and the Pound rose strongly.

Whether or not this is a temporary blip as the market digests the lower growth projections and sells Sterling accordingly or we manage to hold on to these levels is fairly uncertain at this stage but there seems to be more downside risk.

That is because interest rate increases are not only dependent on the path of inflation and GDP, but also on bank funding costs relative to interest rates.

Put simply, what the Governor suggested yesterday is that funding costs need to fall before interest rates can rise, and given the current contagion fears throughout the Eurozone and the unwinding of the Banks SLF facility this year, the chances of that happening in the near to medium term look bleak..

Euro debt worries continue to spook the markets.

Inspectors from the IMF and EU visited Greece yesterday to assess current and future austerity plans, triggering protests in the Greek capital.

The EU looks set to extend maturity dates for Greek debt so unfortunately this story looks set to run and run – which is maybe the reason why it is not effecting the Euro as much as everyone thinks it should.

Sterling is contining its downward spiral against the Euro this morning following yet another weak figure from the UK economy.The Service PMI, the index measuring growth in the services sector was released at 54.30, less than the 56.00 expected and this has pushed Sterling to 13 month lows versus the single currency.

This move comes ahead of the rate decisions from both the BoE and ECB with neither expected to alter their base rates.

Mervyn King and the Bank of England remain trapped between low growth and high inflation and with this likely to linger for many months to come, we may not see a Pound recovery for some time.

Meanwhile, the Euro continues to go from strength to strength- illogically.

The rate hike from the ECB last month with further rises coming over the course of the year have given the Euro a head start over its major rivals and with the US, UK and Japan unlikely to raise rates for some time, the current trend could be set to continue over the Summer.

We will look for clues about the agenda for ECB during President Jean Claude Trichet’s press conference this afternoon.

Sterling took a bit of beating in early trading yesterday after the UK PMI index unexpectedly dropped to a seven month low.Rather than the actual figure, it was the diminishing prospect of a rate hike by the Bank of England on Thursday that saw Sterling drop over a cent against the Euro and Dollar.

After a brief rally this morning, The Pound is beginning to drop back again.

First thing this morning the Nationwide House Price Index showed British house prices falling 1.3% year-on-year and we can expect Sterling to remain under pressure with the release of construction PMI, mortgage approvals & net consumer credit due later.

Sterling looks set to take a back seat for the rest of the week as no change is expected at the MPC meeting on Thursday, a rate rise by the ECB is not completely off the table and the Non farm payrolls from America is due on Friday.

Portugal finally agreed the terms of its bail-out, easing its debt concerns, at least for the next few years, but given the success of the Greek (possible default or restructuring) and Irish (penal rate of interest currently being renegotiated) bail-outs I’m certain this will not be the end of the matter.

Caretaker Prime Minister Jose Socrates said he achieved a good deal – let’s see if he is still saying that in 6 months time, if he manages to cling to power.

Eurozone Sevices PMI also showed a drop compared to forecast, but nothing like the UK and so the Euro is relatively unaffected.