Risk aversion remains the main theme across the money markets this week with equity market continuing to slide and the safe havens of the US Dollar and Japanese Yen performing strongly. Very positive German GDP yesterday gave the euro a boost in early trading but again developments in Greece have swamped any positive euro related news and driven the euro lower against the Dollar and Sterling.

News of large euro outflows out of Greece by citizens is not helping the nagging feeling that a Greek exit from the eurozone is approaching faster than European politicians would like.

They have desperately tried to manage the situation to ensure that if the worst did happen, Greece leaving could be orderly.

The fear is now that politicians no longer have the ability to manage the situation and a disorderly exit may now be on the cards.

The Bank of England inflation report is due today at 10.30.

We have covered what the Governor is likely to outline, namely lower that expected growth and higher than expected inflation.

The market has already built that into Sterling and the news will probably play second fiddle to news coming from the eurozone for the rest of the week.

The UK’s trade deficit narrowed in March, driven in particular by stronger exports to the US, China and Russia.The seasonally adjusted trade deficit in goods and services was £2.7bn, against £2.9bn the month before, the Office for National Statistics said.

Car exports in March were worth £200 million more than the previous month.

The deficit on seasonally adjusted trade in goods was £8.6 billion in March, unchanged on February.

The ONS said that the surplus on trade in services was estimated at £5.8 billion in March- up compared with a £5.6 billion surplus the month before.

The deficit in trade in goods with EU countries widened by £700 million to £4.5 billion in March, compared with the deficit of £3.7 billion in February. Exports were virtually unchanged at £13.2 billion, and imports rose by £800 million, or 4.4%, to £17.6 billion.

Trade in goods with non-EU countries reached record levels, with both imports and exports at an all-time high in March.

Imports to the UK of goods from non-EU states rose by £700 million, or 4%, to £17.3 billion, while exports rose by £1.4 billion, up 12.1%.

That left the overall deficit on goods trade narrowing by £800 million to £4.1 billion, compared with February’s deficit of £4.9 billion.

The value of chemicals exported to non-EU countries rose by £200 million in March. The shipbuilding sector also saw the value of exports rise by the same amount.

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.

China’s inflation rate has drop to 3.4% in April from 3.6% in the previous month and below the Chinese government target of 4%.This will reduce the headache for the government as rising consumer costs have been one of the biggest causes for concern in recent times reaching as high as 6.5% in July last year.

The drop in the oil price has certainly helped China’s progress alongside its bid to improve domestic demand to offset their fall in global demand for their exports.

Recent data suggests that Chinese consumption is struggling as imports grew only 0.3% last month compared to 5.3% in March.

Consequently investors will be keen to see how policy makers act within the next few months, perhaps leading to a cut in interest rates.

Back in Blighty, the NIESR National Institute for Social Economic Research (NIESR)’s reserach indicates that UK GDP grew by 0.1% over the quarter to April following the 0.2% drop in the previous 3 months.

Details of the report revealed that the negative output is expected to widen further as a result of the sluggish economy.

They expect the UK economy to remain broadly flat over the next 6 months according to the report.

These latest figures support the Bank of England’s case to maintain low interest rates in an attempt to boost growth.

As expected both the interest rate decision and the QE programme where left unchanged yesterday.

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.

A study completed by the National Institute of Economic and Social Research (NIESR) is predicting the UK unemployment rate will rise from the current 8.3% to nearly 9% by the end of 2012. The study blames low growth in the coming two years as the UK steers itself out of this technical recession.

NIESR recognized that later revisions may alter this, but said “small quarter-to-quarter movements of this sort are largely irrelevant to the broader picture of an economy that remains very weak”.

The big ticket data release this afternoon is the US non-farm payrolls.

It’s been a mixed bag data wise leading up to today’s announcement so there is a large degree of uncertainty over the actual number.

Consensus estimates are for 175K jobs created in April, initial jobless claims yesterday came in better than expected which point towards a positive number but at this stage it is difficult to call.

The Dollar has regained significant ground against Sterling in the last week and the risks remain to the downside, however if the number disappoints and we could be trading above 1.62 quite quickly.

The sterling/euro exchange rate has broken its correlation with movements in EUR/USD for the time being, with self-governing Sterling strength evident.

This is been confirmed by the shift in interest rate differentials between the UK and eurozone, a move which has gone in favour of GB Pound strength.

The view now points to some further downside potential in this currency pair, with a test of technical support around 0.8067 on the cards.

Mervyn King has lived up to his nickname as “Merve the Swerve” as he rejected criticism for the financial credit crunch crisis.  He blamed the banks, the system and the decision to de-regulate power from the Bank of England in the past.

Mervyn King went on to talk about the challenges facing the banking infrastructure going forward with a need for regulation, resolution and restructure which will be demonstrated next year when the BoE’s new financial policy committee will have the power to regulate banks.

King supported the idea of ring fencing high street bank operations so they have their own financial cushion to avoid failure and noted the necessity for a framework to allow a bank to fail without being nationalised.

Over to the markets and UK PMI services data has just come out significantly worse than expectations with a fall to 53.3 from 55.30 in March, however UK service expectations improved.

UK Nationwide House Price data also came in weaker than expected.  Nationwide expect house prices to be flat or moderately lower over the next 12 months.

The Pound is relatively unchanged on the data.

A key event today is the ECB meeting, it is widely expected that rates will remain on hold but there is an outside chance of a rate cut.

The key focal point will once again be the press conference following the meeting where Mario Draghi will face key questions on the outlook for Europe.

Recently we have been hearing calls for a clearer strategy on how to tackle slumping growth in the eurozone and what role the ECB can play in assisting the system.

A surprise increase in the US ISM manufacturing survey yesterday evening was enough to push the Dow Jones industrial average to its highest level in four years, dragging European bourses higher this morning along with the high risk currencies. Due to the May Day bank holiday in Europe, markets on the continent are playing catch up with the US and UK and are performing very strongly in early trading.

Chinese manufacturing PMI also showed a slight improvement overnight, but is still below the 50.0 level, signifying a contraction in manufacturing output.

This afternoon the ADP employment report is released in anticipation of the non-farm payrolls on Friday with expectations of 175K jobs created in April, not quite the numbers we saw in the first three months on the year but positive non-the-less.

Portugal goes to the market today, issuing six and twelve month treasury bills.

The target amount is only €1.25-1.5 billion, but the auctions will be closely watched as ever and expect overblown hysteria if we any signs of weakness.

Ahead of the auction the spread between the benchmark ten-year bonds is slightly higher, sitting at 902 bps in current trading.

The euro is marginally weaker this morning against the US Dollar and Sterling.

From the data just out, French and German PMI were broadly in line with the flash estimates but German unemployment rose in April and it is this that is leading the Euro weakness this morning.

In a surprise move over night the Reserve Bank of Australia (RBA) has slashed interest rates after concerns over their own economic forecasts. The widely expected move was for a 0.25% cut, however the key rate moved from 4.25% to 3.75%.

This is the first acknowledgment by the RBA that Australia is beginning to be affected by the global slowdown, particular in China.

“This decision is based on information received over the past few months that suggests that economic conditions have been somewhat weaker than expected, while inflation has moderated” according to the RBA.

As you would expect the AUS Dollar has been heavily sold off since the announcement and currently trades at 1.5720 against Sterling, from 1.5564 before the decision.

In other news Spain followed the UK yesterday by confirming they were in a technical recession following negative growth in the first quarter of the year.

This data coupled with poor Greek retail sales falling by 13% and a 0.3% negative growth figure weighed heavily on the single European currency yesterday pushing Sterling higher.

These gains have been given back this morning following UK PMI data which has fallen to a reading of 50.5 following a reading of 51.9 in March and below expectations of 51.5.

The sharp fall is the lowest since Christmas and has been largely attributed to low demand from the eurozone which has hit manufacturing and meant UK exports fell to levels not seen since May 2009.

Consequently Sterling now sits at 1.2213 against the single European currency and Cable at 1.6205.