Developments in France, Greece and Spain continue to weigh on euro sentiment, driving the single currency lower across the board. Investors continue to be risk adverse as European voters take their toll on austerity loving- politicians.

The Spanish government has part-nationalised stricken lender Bankia, taking a 45 per cent stake in exchange for €4.5 billion in emergency loans and we can expect this to be the first of several injections of capital by the Spanish authorities into their struggling banking sector.

The search for a Greek government also looks set to drag on, after the second placed Syriza party in the recent elections failed to form a coalition.

The mandate now looks set to pass to the third placed Socialists in a ludicrous game of pass the parcel, with every failure racheting up the pressure to find a solution.

Much needed bail-out funds are being withheld until a government is in place, but with no end in sight to the election merry-go-round, EU officials need to act quickly to avoid making the situation worse than it already is.

This morning is an important one for Sterling with Industrial Production data due along with the Bank of England announcement on interest rates and the asset purchase scheme at midday.

The IP number for March is expected to show further declines in output but a number to the upside is a possibility after the rebound in construction in the last two months.

As we’ve mentioned before this week, it would be a huge surprise if the Bank of England made any changes to rates or QE.

Australian employment came in much better than expected, 4.9% against expectations of 5.3% catching the markets completely on the wrong side.

The AUD is off around 4% against the USD and GBP over the last few weeks after the central bank cut interest rates and looks set to cut further this year.

The market was quite short the Aussie, and the buying back of those positions has forced a quick 50 point rally overnight.

Voters in France and Greece joined their counterparts in Ireland, Portugal, Spain, Italy and the Netherlands in forcing out leaders or ruling parties over the past two years. Changes in leadership across the eurozone have generally been Euro negative in the immediate aftermath as the markets digest the change in leadership and the euro is pushing towards the key level of 1.30 against the Dollar in early trading this morning.

The French public elected Francois Hollande, the socialist candidate, and a key pledge was to renegotiate the ‘fiscal pact’ agreed by members of the single currency.

The money markets remain nervous of the possibility of renegotiation mostly because of the uncertainty it would create and how it would affect the strong ties forged between Mr Hollande’s predecessor and the German Chancellor.

Also adding to negative euro sentiment is the non-result from the Greek election.

No party secured enough of the vote to form a government.

New Democracy, who polled the most votes of all the parties has not been able to persuade other to form a coalition so it now falls to second place – the radical Syriza party – to try to form a government.

As many in the market have worried, an anti-austerity party in a position of power brings a Greek exit from the euro that much closer.

Away from Europe, the Bank of England meets on Thursday to decide interest rates and the asset purchase scheme. No change is expected to either.

We also have the GDP estimate on Thursday expected to show a return to growth, and also the PPI figures on Friday.

There is little important economic data from the US this week but in Australia we have the budget and employment data out later in the week and given the ACB cut rates last month may turn out to be softer than expected.

Yesterday European shares and the euro came under renewed pressure after confirmation that Spain’s economy was again in recession and German PMI for April was unexpectedly down. To add fuel to the growing fire the Dutch PM and entire cabinet resigned piling political worries on top of economic woes.

Along with a steep fall in shares we saw spreads widening between struggling sovereign Euro economies and Germany, in addition the Dutch/German spread widened.

Lots of risk aversion in afternoon trading yesterday with the main benefactors being the US Dollar and the Japanese Yen.

Today we have started a little brighter and bond spreads have narrowed slightly from yesterday- the main reason for this is that Dutch, Spanish and Italian bond auctions all went well helping to firm up the Euro from yesterday’s lows.

The main take from yesterday is just how quickly things can turn sour and this highlights the fickle position of the ailing euro.

Today we have seen UK data in the form of public sector net borrowing which showed that the government borrowed more than expected for March but still met its annual target.

Tomorrow we see the crucial preliminary first quarter GDP data.

We have seen some bright sparks in the UK economy of late in relation to unemployment data and retail sales.

However the data has been inconsistent and we have seen a weak performance in the construction sector which could lead to a negative number.

Tomorrow’s number if negative would be a huge blow psychologically to the UK’s recovery and will undoubtedly hit confidence in the UK’s recovery strategy and the pound.

Conversely if we see a stronger than expected number we could see the Pound rally further after a strong performance recently.

Rising bank shares have lifted European stock markets amid hopeful economic signals, results from US banks and a report suggesting the ECB was providing more loans to banks than had been thought.Successful French and Spanish bond auctions and falling US unemployment claims also helped improve sentiment.

Bank of America and Morgan Stanley’s results were better than expected.

Commerzbank shares rose 15% after it said it would be able to increase its capital without government help. Also in Frankfurt, Deutsche Bank rose 8%.

In London, Barclays shares rose 10% while Lloyds and RBS were both up 9%.

In Paris, Societe Generale rose 13%, Credit Agricole rose 9% and BNP Paribas gained 8%.

The soaring bank shares helped Europe’s benchmark indexes to strong closes, with the FTSE 100 ending up 0.7% at 5,741 points, its highest closing level since the start of August.

The Cac 40 in Paris closed up 2% while the Dax in Frankfurt gained 1%.

Some of the gains in banking shares were sparked by a report from Morgan Stanley, which said that the European Central Bank was flooding the eurozone banking system with even more cheap loans than had previously been thought.

A new shockwave filtered through the markets on Friday as the credit agency Standard & Poors (S&P)- downgraded France, stripping them of its prized AAA rating. The decision to remove this vital asset in keeping borrowing costs to a minimum left France with a AA+ rating, a judgment that will likely cost billions in higher repayment costs.

S&P said “Europe’s austerity and budget discipline alone were not sufficient to fight the debt crisis and may become self defeating”.

Alongside France, S&P cut the rating of Italy, Spain, Cyprus, Portugal, Austria, Slovakia, Slovenia and Malta though it was expected that these countries would have their ratings lowered.

Overall, the picture isn’t looking good for Europe and with further downgrades likely over the next few months, it will be important to see how the ECB reacts in keeping this ongoing debt crisis under control.

The main winner from this continues to be the US Dollar with further gains against most currencies likely as investors pile more money into the global reserve currency.

For as long as the Greenback keeps this status, it will remain the market leader in these testing times as Europe sits on a knife edge between growth and recession.

There is very little data out today with the only comment of note coming from a speech by ECB President Mario Draghi due at 6pm UK Time.

It is likely he will focus on the downgrade on France and how the ECB will look to repair the damage it has caused.

The euro debt crisis has taken a back seat today with no comments or figures coming from the Eurozone. Maybe it’s because the various European politicians are following the draw of their premier sporting event, the Champions League and have taken the day off. Or maybe it is down to there being no news or progress with sorting out the future of the single currency.

The relationship between Britain and France took a hit yesterday as French Central Bank chief Christian Noyer lashed out at the UK’s economy saying “Britain should be downgraded before any cut to France’s credit rating”.

Prime Minster David Cameron responded by pointing out the UK’s low bond yields and the credible plan in place to cut the mammoth annual deficit.

This aside, the markets are very calm as we finish the week. The US has some inflation figures due out in the form of CPI data as well as some FED members speaking, but these will bring little in the way of movement.

The Greenback has remained strong as invested move funds into the only currency being viewed as a “safe haven” and this will likely continue into the new year as no additional risk will be wanted over the holidays.

After the blow to the euro following the Standard and Poor’s ratings news on Eurozone countries, the currency has managed to regain some form of stability ahead of the EU Summit commencing tomorrow. Hopes that the Merkozy French -German deal which was publicised on Monday will be finalised at the summit are high and the threat by S&P means that the stakes are getting higher should there be a halt in progress this week.

Apart from placing the ratings of fifteen Eurozone countries on negative watch, S&P stated that the EFSF bailout fund may be downgraded too.

The single European currency however, looks to have found form in advance of the summit and the ECB meeting tomorrow, as news of talks to structure the bailout fund into two separate forms looks to strengthen the currency.

In other news the decrease in the Royal Bank of Australia’s new cash rate applied further pressure on the Aussie.

It’s fair to say the timing of the cut was not fully expected however the Aussie drop was restricted by the somewhat neutral RBA policy report.

The announcement did not support the idea of additional easing in the months ahead coupled with the much firmer than expected Q3 GDP this suggests that markets are too dovish on Australian interest rate expectations.

The Euro has continued to fall lower against Sterling in recent times whilst teh Pound looks to have settled into a range.

Sterling sentiment has clearly deteriorated over recent weeks as reflected as the market looks to becoming increasingly short.

The Pound has not been helped with a run of particularly poor data  and yesterday’s UK house price data was no exception, indicating a fall in November house prices alongside retail sales which dropped more than expected.

The ratings agency Standard & Poor’s left the growing mood of optimism about the eurozone debt crisis in ruins last night by warning the wise money markets that 15 of the regions 17 countries face credit downgrades if politicians do not gain control of their economies. S&P blasted Brussels “defensive” management of the crisis blaming the prolonged dispute among European policymakers for destroying investor confidence.

All of the AAA rated sovereigns which includes Germany and France have been placed on “negative credit watch”.

S&P highlighted that the French banks were a particular worry as the amount of external debt has risen above France’s GDP.

The timing could hardly have been worse as German Chancellor Angela Merkel and French President Nicolas Sarkozy sent investor sentiment soaring earlier.

Their united front had led to a significant drop in the borrowing costs for many of the struggling Eurozone nations including Italy, whose 10 year yields dropped below 6%.

The other announcements due out this week have been made rather insignificant though the central bank meetings due out on Thursday will maintain some weight in the markets.

The Bank of England will keep their base rate on hold at 0.5%, but any comments from the MPC Committee will be looked into.

The ECB will reveal their decision 45 minutes later and they are expected to cut their rate back to the 1% it was reduced to during the height of the credit crunch.

If this is the case, it will show a remarkable turnaround in the fortunes for the eurozone as the interest rates seemed to be on an upward curve in the 2nd quarter of this year.

We are set for an extremely busy and important week for the eurozone.The main event looks set to be the announcement of a deal on fiscal union between member states on Friday night, but what the market expects this deal to look like and what the deal actually looks like may well turn out to be two different things.

What the euro needs is further fiscal integration between members with the plan of a centralised treasury to eventually raise and distribute taxes.

What the French and Germans are likely to propose is the fiscally stronger countries get a greater say in how the weaker periphery run their economies.

Thursday sees the ECB monthly meeting, with another reduction in interest rates expected.

ECB head Mario Dragi has also hinted in a recent speech of large scale bond purchases by the bank.

The much softer tone suggests a deal on government budgets might be closer than the market thinks.

Keeping with all things Europe, we also have a large amount of data to digest this week including eurozone retail sales, German CPI and the closely watched ECB monthly report which will detail the size and scope of lending to European banks by the central bank.

Sterling continues to hold its ground versus the euro and Dollar despite the dire announcement by the Chancellor last week, who downgraded his growth projections for the UK economy.

The resulting changes to the UK outlook now mean the Government will not balance its books until 2016 at the earliest.

The reason for Sterling not pushing lower in the face of a worsening outlook is probably that it is the least bad option in the face of the continuing European problems and the potential for QE3 in the US.

That said the Bank of England looks set to announce an increase to its own asset purchase scheme on Thursday at the MPC meeting.

Governor Mervyn King was in very gloomy mood as his announcement the Banks financial stability report last week and it is likely that the BOE will take action this month rather than waiting for the New Year.

Last week saw significant risk aversion played out as stock markets dropped dramatically where as this week looks a little firmer. Articles in the Italian media suggest that the International Monetary Fund (IMF) is preparing a €600 billion deal for Italy in the event of deterioration in the debt crisis- this could provide market support in the early part of the week.

Further support may also come from reports in Germany that German Chancellor Merkel and French President Sarkozy are putting together a “Stability Pact” for euro countries similar to the Schengen agreement.

Nevertheless, neither story has been confirmed so as usual the prospect for disappointment is high.

The sell on risk on rallies environment is likely to persist for a while longer despite such reports.

As we end November market orders are likely to fall and liquidity is likely to thin with plenty of events and data on tap… volatility is guaranteed.

First up includes bond auctions in Belgium and Italy today and France and Spain later in the week against the background where Germany’s failed bond auction last week has added further anxiety in bond markets.

Under the spot light tomorrow will be a European Finance Ministers meeting, given the lack of steps forward on many issues especially on the subject of Eurobonds.

With risk appearing back on the menu, traditional risk currencies like the Euro and Aussie have rallied in the early part of the session.

One would expect any gain in the Euro to prove limited and weak if the European press reports are confirmed.

EUR/USD will find upside resistance around the 1.3412 level, while the risk of a downside test of support around its October 4 low at 1.3146 remains high over the coming week.