European money markets have fallen as the continuing political uncertainty in Greece and Spain undermines investor confidence.Greek President Karolos Papoulias failed to form a coalition government through talks on Sunday and will continue discussions with political leaders on Monday evening.

Bank shares are worst hit, particularly in Spain and France, with Madrid’s Ibex index down 2.8% and the CAC down 2.3%. London’s FT 100 share index is down 1.7% and Germany’s Dax down 2%.

French banks were among the biggest fallers as investors worried about their exposure to other troubled eurozone countries. BNP Paribas was 3.4% lower, Societe Generale lost 3.3% and Credit Agricole fell 3.4%.

Spanish banks Banco Santander and Bankia were down 3.4% and 4.4% respectively, as they said they would set aside an extra £2.16 billion (2.7 billion euros) £1.68 billion euros respectively to meet new government requirements aimed at cleaning up the country’s ailing property market.

Meanwhile, both Spain and Italy carried out successful bond auctions on Monday.

Appetite for Spanish and Italian debt was more than strong enough, but the return demanded by investors in Spain’s debt was higher than in previous auctions, reflecting a dip in confidence.

The difference in the rate demanded by Spanish 10 year bond investors over the equivalent German bunds hit 4.83%, its highest level since the creation of the euro.

The yield, or interest rate, on Spain’s key 10 year bonds, which are traded on the market, jumped 23 basis points to a record high of 6.22%.

Greece’s lack of a government puts in doubt its ability to stick to austerity measures imposed as part of its financial bailout. Without holding to agreed cuts it will not get the rest of the support funds it needs to function.

Adding to the lack of clarity is the fact that anti-bailout parties did well in the elections.

Anti-austerity feeling may be growing in Germany as well as Chancellor Angela Merkel’s party suffered a defeat on Sunday in an election in North Rhine-Westphalia, the country’s most populous state.

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.

The spotlight is returning to Europe after a brief period of calm. The spread between the benchmark German 10 year bond and its Spanish and Italian counterpart’s widened on continued bearish data and rumours that GDP estimates across the southern Mediterranean countries will be sharply revised downwards.

The uncertainty remains whether the eurozone has enough left in reserve for when Spain or Italy need emergency rescue loans.

The worry is dragging down equity markets from recent highs along with risk currencies like Sterling and especially the commodity currencies which have been the main casualty of recent risk aversion.

There are several bond auctions in the eurozone today; Germany and Italy tap the well for smallish amounts of €3 billion and €5 billion respectively.

There will be strong demand for German debt as ever, but with the problems from last week’s Spanish auction fresh in the mind today’s offering from Italy will be closely watched for overall demand and also the price the market charges the Italian government.

The ECB meeting is on Thursday this week where it is unlikely that they will make any changes to interest rates or the special liquidity measures.

With risk sentiment waning, extra importance will be given to the Chinese GDP data due on Friday.

The data is expected to be around the magical 8% level, as it always seems to be.

Anything lower would be a real shock and compound the bearish trend we’ve followed this week.

Europe’s 17 eurozonegovernments have agreed to deliver €500 billion in a new bailout funds today in the hope of erecting a firewall big enough to contain the sovereign debt crisis and encourage the International Monetary Fund members to commit a similar sum to emergency reserves.But the eurozone finance ministers, meeting in Copenhagen amid calls to erect the “mother of all firewalls”, ditched explicit earlier proposals to keep a further €240 billion (£200billion) in reserve for the next two years.

The deal conformed to German prescriptions for a minimalist bailout fund, a recipe that the European commission in advance described as inadequate to the challenges confronting the euro.

Ministers nevertheless endeavoured to impress the bond markets, the Americans, and the Chinese, trumpeting the agreement as worth “more than a trillion dollars” in the hope that this will press the big IMF donors into doubling the monetary fund’s reserves to a similar figure next month.

“We are now in a strong position for discussion on the IMF in April. It is a good signal,” said the French finance minister, Francois Baroin.

“All together the euro area is mobilising an overall firewall of approximately €800 bn, more than $1tn,” said a Eurogroup statement.

But that figure included €100 billion in bilateral loans to Greece from EU countries in 2010 as well as €200 billion to Ireland, Portugal and Greece from the temporary eurozone bailout fund which closes next year, although those three programmes will run their course until 2015.

The Copenhagen meeting degenerated into acrimony and some chaos when the Austrian finance minister, Maria Fekter, upstaged the eurozone leaders by first announcing an €800 billion firewall.

Jena-Claude Juncker, the veteran Luxembourg prime minister who has been chairing the eurogroup for eight years and whose term expires in June, threw a hissy fit and cancelled a media conference at which he was to unveil the decisions.

The new money comes in the form of the European Stability Mechanism (ESM), the permanent eurozone bailout kitty and embryonic European Monetary Fund which starts in July. The ESM’s launch has already been brought forward and ministers on Friday also agreed to speed up the process of paid-in capital to get the fund fully operational within two years.

Its lending capacity was capped at €500 billion, as has long been planned.

A draft statement yesterday said that the spare €240 billion would be held in reserve for emergency use, but was dropped today.

The permanent fund’s lending capacity hinges on €80 billion being paid in five instalments till 2014 in order to retain a triple-A credit rating, meaning that it could be two years before the fund is operating fully as foreseen.

But the parallel running of the current temporary and the future permanent funds will ensure a lending capacity of €500 billion, the ministers said.

Europe took a major step towards greater fiscal integration overnight, as all EU members except the UK and Czech Republic agreed to German measures to reduce budget deficits and allow greater oversight by the European commission. The pact should be in place by March with the ratification and implementation to follow shortly after.

Automatic fines of around 0.1% of GDP will be levied on countries who fail to reduce their deficits by the agreed proportions.

The fines smack of a token gesture given it will be one of the PIIGS that fail the tests and clearly they would not be expected to pay, and the fact that the Maastricht treaty imposed broadly similar rules which were blatantly broken by all member states is one of the reasons Europe finds itself in its current state of woe.

As with recent EU meetings, the news will likely trigger a short lived Euro bounce before selling pressure resumes.

Sterling continues to climb against the Dollar driven by the recent surge in the value of the Euro against the Dollar.

Apart from PMI figures, there is little by the way of meaningful UK data out this week to move Sterling so expect it to stay in lockstep with the Euro-Dollar.

Expectations for the PMI data is expected to show a mixed bag, but given the GDP reading earlier in the week there is more chance of disappointing readings than surprises to the upside and that should translate into Sterling weakness.

US data due today and for the rest of the week include personal consumption expenditure which is expected to show a slight increase and ISM manufacturing on Friday is also expected to show a positive reading.

Over recent weeks we have been seeing an about turn in the way the Dollar reacts to positive US data. Over the past few years the risk-on, risk-off theme has been the dominant driver of Dollar movements where good US data was seen as risk-on and the Dollar fell.

Recently we are seeing a reversal in the theme, and positive US data is increasingly leading to the US Dollar strengthening.

German Chancellor Angela Merkel told Davos-”We need a big rethink”.Germany’s Chancellor Angela Merkel has told the World Economic Forum that a “big rethink” is needed in the eurozone within the global economy.

“Structural reforms that lead to more jobs are essential,” she told delegates at the Swiss resort of Davos. “Do we dare to be more European?”

The eurozone is still struggling with a sovereign debt crisis and is trying to agree reform to its political system.

But many want Germany and other nations to boost the size of their rescue fund.

The International Monetary Fund (IMF) wants the eurozone to inject more cash into its rescue fund.

The IMF wants the sum available for bailouts to grow beyond 500bn euros (£416 billion) to ensure talks between private creditors and Greece do not grind to a halt.

The situation is urgent according to the IMF, which recently predicted that the economic growth rate in Europe could halve this year from an earlier estimate of 3.3% if the eurozone crisis remains unsolved.
Lessons learnt

Mrs Merkel disagrees with Ms Lagarde about what is needed.

“We have said right from the start that we want to stand up for the euro, but what we don’t want is a situation where we are forced to promise something that we will not be able to fulfil,” she said.

Mrs Merkel said that the austerity reforms being enacted – currently being felt from the Irish Republic to Italy – had to be balanced with reforms of how Europe is governed.

Mrs Merkel also acknowledged “tensions” between countries that have adopted the euro and those that have not inside the European Union (EU).

Given that the main euro paymasters Germany- and the IMF disagree on how to solve the euro credit crunch- there is only one way this story is going to go.

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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.

Festive cheer in the money market seem to be running out already as we move towards the end of the first trading week of 2012. Disappointing Italian and Spanish PMI data more than offset a decent German figure and the eurozone is looking more and more likely to be heading into another recession.

The euro was under pressure for most of yesterday as risk was dumped and the US Dollar strengthened.

The theme is continuing this morning as the single currency continues to be sold; European banks continue to make headlines for the wrong reasons as they park newly created ECB cash back at the central bank rather than lending or investing it in the real economy.

Retail gloom continues to hang over the UK with many of the retailers reporting crucial Christmas figures this week.

Next shares were pummelled after they reported disappointing sales over the festive period and set a gloomy tone as we wait for results from rivals M&S.

John Lewis were a ray of light in the gloom, posting impressive sales growth compared to last year, but most if not all retailers are suggesting that economic conditions remain a real concern and are expecting a challenging year.

The Pound has opened the year in much the same way as it finished the last, namely taking a back seat to the Euro and Dollar with economic fundamentals remain less of a driver than politics.

The wise money is hoping for a clear sign of the economic picture on Friday from the Non-farm payrolls, either showing the recovery continuing or a worsening picture and the prospect of further QE this year.

More likely is that the number shows the US economy to the chugging along slowly, leaving both the Fed and the markets disappointed.

European stock markets started the year in optimistic style with gains led by the German DAX index after the release of better than expected levels for eurozone purchasing managers indices (PMI). Furthermore, Chinese data indicated a rise in its PMI which helped to boost risk sentiment.

The combined eurozone data however, remained at a weak level, contracting for a fifth month in a row, and remains constant with eurozone recession.

One would not expect this equity rally to continue over the rest of this week, as risk aversion is set to play out alongside the on-going Eurozone debt and global growth worries.

Indeed, both French and German leaders in their new year messages talked about the risks ahead.

A summit between Germany’s Merkel and France’s Sarkozy is planned for January 9th ahead of an EU Finance Ministers summit on January 23rd. It is unlikely that there will be any major policy decisions in Europe before then.

In the meantime, German press reports suggest Germany is pushing for an even bigger write down of Greek debt than previously approved will only add to risk aversion over the short term.

The report in the Greek press highlighted the prospect of a 75% write down of Greek debt a far cry from the 20% proposed some months ago.

Eurozone markets continue to be troubled by the scenario of credit downgrades by major ratings agencies at a time when many countries have to issue hefty amounts of debt to suit their funding needs.

Against this background the EUR is set to remain under pressure, with a notable drop below EUR/JPY 100, its lowest level in over a decade registered. Reflecting the deterioration in sentiment for the currency, EUR speculative position hit an all-time low at the end of last year. This is unlikely to reverse quickly, with sentiment set to deteriorate further over coming weeks and months as the EUR slides further.

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.