The sentiment in the money markets shifted again over the weekend as China commented on the Eurozone’s planned bailout package.

The most recent comments stated that China will co-operate and said “a prosperous and stable Europe is important to China’s stability and development”, but it will not be the “saviour” 0f indebted nations- handing over “dumb money”.

This is likely to keep French President Nicolas Sarkozy up at night as he has been on the phone to his Chinese counterpart saying Beijing has a “major role to play” in Europe’s recovery.

The euro loss some of the ground it made towards the end of last week as traders looked at the potential of this new bailout package failing apart.

Europe needs China to add at least €60bn on top of what they already have put in to make this new step in securing Europe’s future viable.

Without it, there aren’t enough willing sovereign states or wealthy individual investors to progress and the top brass across Europe will have to look for yet another new way of saving the single currency.

What a day! Risk was forcibly thrown on the table as markets interpreted was most  had seen as just bare bones of a European rescue plan as reason to be cheerful,  and risk assets surged throughout the European session and overnight. 

Not far behind the way on were the banks, which contrary to every other industry that receives a recapitalisation managed to convince the market that getting €106bn to shore up creaky balance sheets it is a good, rather than negative development.

Also helping sentiment was the American GDP figure although only inline with estimates, reassured investors that the world’s largest economy is still growing, albeit at a sluggish pace.

Reports today suggest that euro leaders will go cap in hand to China asking them to be a significant investor in the European Bail-out fund.

This move which was widely expected given the size of China’s foreign exchange reserves and their perceived desire to diversify away some of the vast amount of Dollars they are holding.

The interesting thing will be finding out the political cost of the money – silence on the currency manipulator tag- or human rights perhaps?

Whatever the economic and political motivations behind the news will lend strength to the Euro as we move into the weekend.

The publication of the Bank of England’s Quarterly Inflation Report headlines the economic calendar today.

However the market will be looking to Governor King’s interpretation of the report at this morning’s press conference. It will be looking to see if he continues to be more dovish than the projections in the report which would see weakness in GBP.

In the eurozone, the situation in Greece remains in focus this morning and has done over the last 24 hours.

Conflicting messages emerged yesterday from both Greece and Germany. Ultimately it seems no new agreement has been reached on a new bailout package for the country and so the debate will continue.

For now healthy risk appetite, evidence of which we have seen in the positive performance of global equities over the last 24 hours, is acting to support the Euro.  German CPI data has already been released this morning and came in as expected at 0.2%.

Mixed results from a slew of economic releases from China this morning- inflation held above 5% in April and lending exceeded analysts’ estimates, signalling that further monetary tightening may be needed to cool the fastest-growing major economy.

Consumer prices rose 5.3% from a year earlier and banks extended £71 billion (74 billion Yang) of local-currency loans.

The headline CPI reading has outpaced the government’s 4% target every month so far this year and Vice Premier Wang Qishan said inflation was the “most pressing problem” facing his country earlier this week.

Currency conflicts at the G20 gathering in Nanjing continue to undermine markets with the obvious divisions between member nations on the way forward causing the very moves that participants are looking to correct.

He adds that becoming a constituent of the IMF’s currency basket would be the clear evolution.

The European delegates remain wary of further Dollar strength with the French President, M. Sarkozy summing up the concern when he argued against the Euro, or any other currency, usurping the Greenback role as the global reserve medium.

He added that recent Euro strength versus the Dollar was unjustified.

Overnight, we saw the stronger Dollar from the last few days give up some of its gains on comments from Federal Reserve member Bullard clarifying his reported remarks from the day before.

He said that there is no consensus on the FOMC about ending QE2 early, and that this is unlikely to take place.

He also said that the Federal Reserve would be able to tighten policy by not necessarily pushing up official rates, but by starting to sell back assets adding that this cycle of tightening would be far more difficult to manage.

The weaker Dollar / stronger Euro scenario was further enhanced by yet more comments from ECB Board members, Bini-Smaghi and Stark who both cemented in the probability of a rise in the official Euro interest rate at next week’s regular meeting.

The former talked of rates being returned to normal levels in a “gradual way” whilst Stark pointed out the fact that policy rates at present levels were exceptionally low.

The bank has already raised capital requirements once this year, following a number of hikes last year, and has raised interest rates three times in the past four months.

Inflation in China, now officially the world’s second biggest economy, is growing at 4.9% a year.

High levels of lending helped China through the global downturn and contributed to the economy’s 10.3% growth last year.

However, concerns about the economy overheating and price rises is causing unrest, as they have done in the past, mean the government and central bank are now keen to clamp down on lending.

The measures taken so far have had little effect, with the rate of inflation rising in January and economic growth picking up in the final three months of last year.

Analysts, therefore, expect further measures in the coming months.

The Bank of Japan left both their official rates and the size of their asset purchase programme unchanged (zero – 0.1% target and Yen 5 trillion respectively) but did issue a slightly more upbeat assessment of the domestic recovery – a change in dialogue from the previous month which allowed the Yen itself to initially firm, although the ground was then lost to a firmer Euro.

The Australian Central Bank’ minutes painted a very rosy picture of their own domestic economy going forward.

Despite the expected impact to GDP of the severe flooding, the RBA view is that the economy will claw back the loss during the 2nd quarter and that solid job growth, tighter labour market and the medium term inflation outlook will mean that the current slightly restrictive policy stance remains appropriate.

UK inflation came in at +0.1% m/m +4.0% y/y which was exactly in line with median forecasts the main driver being fuel, restaurant prices, furniture and alcohol.

This has pushed Sterling higher this morning and now sits GBPUSD1.6091 and GBPEUR1.1889.

However, the real importance in the figure will be seen tomorrow when the BoE’s governor, Mervyn King explains the current strategy following the publication of the Quarterly Inflation Report.

Sterling still underpinned on the higher rates, sooner rather than later scenario.

The Greenback fell to a two month low against the euro yesterday as speculation that the US economic recovery will remain sluggish and mounting speculation that European officials are successfully addressing the region’s debt crisis.

The Chinese Yuan also reached a 17-year high against the Dollar as Chinese President Hu Jintao met with President Barack Obama at the White House.

Meeting yesterday for the eighth time, both leaders emphasised the importance of increased trade and said their two countries can keep building commercial ties while working through differences on currency policy and human rights.

The forex markets took a bit of a back seat during the day whilst attention turned to interest rates in general and monetary policies in particular.

With global central banks starting to look at normalising policies and thus interest rates, traders have edged yields higher almost across the board.

The next step looks likely to be the re-introduction from investors of carry trades and in order to achieve this, a funding currency must be sought.

The obvious choices are the popular Yen and Swiss Franc but there are perverse arguments for using the Dollar or Sterling as well.

Could be interesting once rates start moving higher

UK public borrowing figures have just been released and are, in a word, dreadful.

Sterling dropped over half a cent against the Dollar on the back of the announcement and continued low consumer confidence data is also weighing on the Pound in early trading.

Festive cheer for Sterling seems to in short supply in the market in the run up to Christmas.

One point worth mentioning was regarding the one day trade forum hosted by China overnight.

In it, Vice-premier Wang Qishan expressed support for the European Unions attempts to control the sovereign debt crisis in Europe.

The news helped the euro claw back some of the losses incurred in the European and American trading sessions, but this morning’s announcement by rating agency Moody’s that it is placing Portuguese debt on review in light of a possible downgrade, means the Euro has started the day on the back foot.

On the plus side for the single currency, German consumer confidence remains high according to figures released this morning. But it has slipped back from highs of a month ago and missed the forecast level of 57.

Yesterday China intimated that their interest rates will be kept on hold in spite of inflation rising by 5.1% annualised, and the lack of liquidity on the run up to Christmas has placed the dollar on a downward spiral rather than any economic fundamentals.

We started the morning with both Cable and Euro/Dollar in neutral territory from a technical analysis point of view but with projections for year end still for a marginally stronger Dollar – if only on ‘traditional’ end of year demand.

As for the rest of the day we have three US data releases before the release of the outcome of this month’s FOMC meeting.

Retail sales are expected to dip from last month’s strong figure and no change is expected from the Fed to either the interest rate or the current level of stimulus measures.

The recent pick up in US yields will maintain some concerns over the decisions but most analysts expect no change in anything.

Elsewhere, Moody’s said that the recent US tax proposals increase the probability that over the next couple of years, the US AAA rating would be put on outlook negative given that the positive effects from higher growth would be outweighed by the negatives.

The money markets have been surprising muted in the last week despite market moving data.

Normally this would have led to a surge of risk in the markets as investors respond to the healthy data- the main beneficiaries of this would be the Euro and the Aussie Dollar and selling of US Dollar.

However investors have taken a wait and see approach- this could be due to concerns still awash in Europe but more probably it is related to fears that China’s CPI and PPI due out on Sunday is expected to be much higher than anticipated and thus it will lead to a rate rise.

Although China is leading the drive to recovery there is always the concern that their economy may overheat and it is precisely these concerns that are holding back the move to risk.

Yesterday the MPC decided to hold rates and leave stimulus measures untouched- we will need to wait two weeks for the BoE minutes to see the thinking behind the decision.

Also the minutes will highlight the sentiment in the MPC- will the hawk/dove divide widen?

The Pound is slightly up this morning against the USD and EUR- interestingly there was an article in the Telegraph trumpeting the pound for 2011.

According to Barcap they see the pound being the star of 2011 and GBP/USD hitting $1.82 and GBP/EUR 1.28.

Wise Money cant remember the last time the pound was talked up!

The reasoning behind the strength will correlate with gains in the FTSE and the deliverance of the cuts to the deficit boosting the pound…mmm tell that to the revolting students.