The euro enjoyed its first strong day of 2012 yesterday with signs that some confidence could be returning to the single currency.

Negotiations had taken a turn for the worse over the weekend after the authorities asked investors to accept new bonds yielding 3.5% rather than the previously agreed 4%.

The Greek government had hoped to complete talks by Monday, but as yet, no agreement has been made.

However, Greek finance minster Evangelos Venizelos said progress was being made and this was one of the main reasons for the euro strength.

He has now set a new date of 1st February to conclude talks.

Although these comments have improved the confidence level of a deal being agreed, until any deal is signed, expect the euro to remain weak as the threat of a default is still alive.

The Bank of Japan kept their interest rates fixed at 0.1% as the bank noted that the Japanese recovery is moving slower than expected.

The strong Yen remains a problem for the economy with corporate revenues likely to be down as a consequence.

The ongoing debt problems in the eurozone remain the biggest risk to the Japanese economy.

Sterling has remained in the middle against its major rivals as the euro strengthened against both the Dollar and the Pound dragging Cable higher with it.

The main news out this week for the UK is the release of 4th Quarter GDP with a -0.1% figure expected.

This significant change in momentum has been priced into the value of the Pound though it will be a massive blow to the global recovery and could be the first of many negative GDP figures from around the World as a second recession starts to bite.

The British economy is expected to stagnate in the first half of the year according to the British Chamber of Commerce (BCC), with at least one quarter of negative growth expected.

The government needs to make important decisions and actually act on them to maintain confidence and investment levels, which as promised in the Chancellor’s autumn statement included improving the flow of credit to businesses and infrastructure projects.

Although we are about to see another high speed rail line announced today, the BCC warning is timely, and will hopefully persuade the government that expansionary austerity is not delivering the results that the OBR and Chancellor were hoping for.

The Bank of England has long been suggesting monetary policy cannot be the only tool to lift the economy back towards levels of activity seen before the financial crisis, and will be firmly behind the BCC’s suggestions.

In the MPC meeting on Wednesday and Thursday the main discussion will be whether to expand the QE program.

Further stimulus is probably on the cards, the only question will be when the Bank acts.

For the Pound this means it will come under further pressure against its major trading partners especially the Dollar, which is being boosted from a decent data flow in recent weeks.

With the ECB unlikely to drop interest rates again, the main focus on a busy Thursday will be the exact phrases new ECB chief Mario Draghi uses in his press conference.

The strange relationship between the markets and the head of a central bank means every word uttered is scrutinised in microscopic detail to try to second guess the central banks next move.

Special attention will be given to Mr Draghi when he talks about the ECB plans for bond buying in the secondary market and/or any plans for large scale money creation which it is under pressure to commence but has not yet done so because of intense German opposition.

Yesterday’s move in the euro tells you all you need to know about the markets confidence in European leader’s current solution to the on going crisis.

The Euro-Dollar pair continues to trade towards the 1.30 level this morning which is keeping downward pressure on Sterling against the Dollar and slowly pushing the Pound higher against the Euro. The 1.30 level is key; if we manage to break through it to the downside, there is the possibility of a larger move lower but it is looking well protected at the moment.

The Federal Reserve minutes last night indicated the Central bank is continuing the wait and see strategy, indicating that it will wait for inflation to settle before another round of QE is considered.

The Fed also indicated the severity of the strain in financial markets indicating it posed significant downside risks to the economic outlook. Retail sales data yesterday was disappointing, especially given early reading from Black Friday suggested improving conditions in the American high street.

Two positive data releases in a row, well I never! UK inflation fell slightly yesterday and this morning unemployment data came in slightly better than expected.

The overall unemployment rate held steady at 8.3% but given that expectations were for a significant increase the mere fact that is unchanged feels like a huge positive swing. As with the Dollar the Pound will continue to play a back seat role as events in the Euro-Zone remain the primary driver of the markets.

The UK’s monthly inflation report brought another set of disappointing expectations for Britain’s outlook over the next 3 years.

The report goes on to say the Bank predicts sluggish growth of around 1% for next year with the slump lingering into 2013.

Based on these forecasts and the Monetary Policy Committee’s dovish view, the forecast is for £50 billion more of quantitative easing in early 2012 and a further £25 billion towards the middle of the year.

This is on-top of the extra £75 billion extension to the asset buying programme.

BoE government Sir Mervyn King warned “We have been going through extraordinary times and in such circumstances, there are limits to what domestic monetary policy can achieve”. All in all, a pretty dim look going forward for the UK.

We also had the UK’s Retail Sales figure for the previous month released today showing a 0.6% increase MoM.

This had very little effect on Sterling as the markets are continuing to move on the bigger issue surrounding the European debt crisis.

The euro has remained weak on the back of this while the Greenback has continued to strengthen as investors look for a safer place for their money.

Pressure was mounting on Silvio Berlusconi‘s coalition government after it failed to agree on tough new EU measures aimed at reassuring the markets that Italy’s sovereign debt is on a sustainable path.

The news come on the back of rumours yesterday afternoon that today’s meeting of EU leaders has been postponed, which briefly caused a Euro sell off, before the single currency bounced back after it was confirmed that the meeting would go ahead as planned.

The markets are very quiet this morning, almost as if they are waiting for something.

The announcement will come this evening, fingers crossed we get definitive answers on all three lines of attack, the EFSF, bank recapitalisations and Greek hair cuts so the EU gets breathing space to address the more important problem of deeper fiscal integration.

UK’s David Cameron is facing a backlash from within his own party after half of his backbenchers dissented from the Government line in a vote over a referendum on Britain’s membership of the European Union.

The vote was defeated by way of support from Labour and Lib Dem MP’s, but the result was embarrassing for the Prime Minster because of the scale of the revolt from within the Conservative Party.

Unity within Government is being looked at closely by the markets and Mr Cameron cannot let any perceived cracks that are opening within the ruling party get any bigger, especially at a time of austerity in the wider economy.

Eurozone politicians already had a lot on their plate this week.

Large problems to overcome by themselves, but made even harder because the 17 Euro member countries seem to have annoyed the remaining 10 members of the European union outside the Euro, who for fear of being marginalised now want to be at the crucial meeting on Wednesday.

The 10 countries involved at such an important meeting who, although suffering economically, are not even on the same page as most of the eurozone.

This can only make the decision making process harder, especially if they are only there to look out for their own interests in terms of ceding more power to Brussels.

Naturally the Euro is shrugging off all doubts over its future and continues to trade over 1.39 against the Dollar and is steady from yesterday versus the Pound.

The US Dollar fortunes over the coming days are almost completely tied to the success or failure of the EU meeting tomorrow.

We saw risk on yesterday in the American session with equities up across the board and the corresponding weakness of the Dollar after a decent European morning for the Greenback.

Positive PMI data from China and decent earnings lifted sentiment that has carried through to early trading today.

The British economy may already be contracting according to Martin Weale of the Bank of England’s MPC, who suggests 4th quarter growth in the UK, estimated at zero anyway, may be negative and indicate the onset of a double dip recession.

No doubt also justifying the MPC decision for further QE, Mr Weale was also much bolder than usual.

MPC interviews and highlights the real concern at the Bank that as things may be set to get significantly worse for the UK over the next year.

UK inflation figures were published this morning showing that price rises are still rocketing. 

Normally, a strong inflation number indicates that interest rate increases could follow and thus we see a gain in the value of the currency.

However, we are not in normal market conditions and the uptick in inflation will not be reflective of future rate increases as the Bank of England expects inflation to fall back towards 2% in time.

The current weak growth that is threatening the UK’s recovery continues to overshadow inflation and with the risk of a double dip recession still lurking, the BoE has no choice but to keep interest rates low.

The fact that the number was higher than forecast is actually a negative for the pound and we have seen the pound dip against the US Dollar and slightly against the Euro since the numbers were released.

Late in yesterday’s trading, the Euro lost value as pessimistic comments from Angela Merkel dampened the positive mood that was building towards the October 23 summit.

Wise Money expects the euro and the US Dollar to be volatile ahead of the summit as the Eurozone leaders hammer out further bailout measures to support the single currency and some of its ailing economies.

A QE3 could still be launched according to the Federal Reserve minutes released last night, with two on the ten strong FOMC committee suggesting the current US economic outlook could justify stronger policy action.

Which is why the much more potent QE3 is being kept in the wings should we see another deterioration in outlook.

The news has gone some way in tempering the recent Dollar strength we have seen against Sterling and the Euro alongside investors regaining their risk appetite over the past few days.

Bank recapitalisations in Europe are fast becoming the new battle front between the banks and governments, with the head of Deutsche Bank saying the lender will do everything in its power to avoid a forced recapitalisation.

Interestingly Mr Akerman suggested that pressure from governments to hold eurozone bonds had cost the bank close to €400 million this year alone.

The Euro continues its tear higher on the back of higher than expected German CPI this morning, the ECB is heavily influenced by the German inflation hawks and so if inflation continues to climb over Europe the probability of the ECB cutting rates begins to fall.

Disappointing unemployment figures yesterday in the UK had surprisingly little impact against the Dollar and Euro.

The number is extremely worrying, given jobs are the lifeblood of the economy, and lend weight to the Bank of England’s thinking over further QE.

We can expect the jobs situation of get worse before it gets better – especially in light of the looming government cuts ramping up next year.

The euro pushed towards a 3 week high against the US Dollar as the markets became more optimistic on a concrete deal by the end of the month for Greece and the Eurozone. 

ECB president Trichet also stated that commitments made by Greece should mean that it can avoid default.

This flurry of optimism does not eclipse a still sceptical market, but it has given a boost to the single currency- so far the euro has pushed up over 1% against the USD in early trade.

Despite the above positives for the Eurozone in other news Slovakia voted no to a legislation to increase the firepower and guarantees for the European Financial Stability Facility (EFSF).

All other countries have ratified the changes but resistance from Slovakia has raised tension.

It is expected that another vote will pass the changes tomorrow- however this is at the expense of the opposition getting their back scratched in a coalition reshuffle.

In addition European banks still remain on alert as Spanish bank Banesto missed its profit targets and the Bank Of Ireland was downgraded.  In a nutshell the mix is now good news/bad news as opposed to bad news/bad news and so the Euro has managed a move to the upside.

UK data was again poor this morning with UK unemployment hitting a 15 year high at 8.1%.

The Pound has still managed to push up against the USD this morning- this is tracking the move higher in risk on EUR/USD and is not due to pound strength.

MPC member Dale noted that the vote for more QE in the UK was due to the UK economy slowing in Quarter 3 and the expectation that it will slow on Quarter 4.

Today’s unemployment certainly backs up this slowdown, however the key test for the MPC is whether CPI will remain above 5% for the medium term as the expectation is that it will fall towards 2%.

However, the firm emphasised that the downgrades did not “reflect a deterioration in the financial strength of the banking system”.

Moody’s also downgraded nine Portuguese banks, blaming financial weakness.

Shares in both RBS and Lloyds were among the FTSE 100′s biggest fallers, down 3.7% and 2.7% respectively in afternoon trading.

Seven UK building societies were among the firms downgraded, a move that the Building Societies Association (BSA) called a “normalisation” that had “been expected for some time”.

“It does not represent any change in financial strength and it is business as usual across the sector,” the BSA said.

Analysts and investors watch closely the ratings that firms such as Moody’s put on the creditworthiness of companies and governments.

Along with Standard & Poor’s and Fitch, Moody’s is one of the big three agencies. Their ratings influence heavily the amount interest that companies and governments pay to borrow money.

“The downgrades have been caused by Moody’s reassessment of the support environment in the UK which has resulted in the removal of systemic support for seven smaller institutions and the reduction of systemic support… for five larger, more systemically important financial institutions.”

The downgrades include a two-notch cut for government-controlled RBS, to A2 from Aa3, and a cut of one-notch, to A1 from Aa3, for Lloyds TSB, a division of part-nationalised Lloyds Banking Group.

Spanish bank Santander had its UK business downgraded by one notch, to A1 from Aa3, while Nationwide Building Society suffered a two-notch cut, to A2 from Aa3.

Other institutions downgraded were Co-operative Bank, and the building societies Newcastle, Norwich & Peterborough, Nottingham, Principality, Skipton, West Bromwich and Yorkshire.

The rating cuts did not concern HSBC, Barclays or Standard Chartered, Moody’s said.

RBS said it was “disappointed” that Moody’s announcement did not reflect the “significant progress” the bank had made to restructure it finances.

Lloyds said that it believed Moody’s was reflecting what was already understood in the market, and that it would “have minimal impact on our funding costs”.

Nationwide said that Moody’s announcement was part of an industry-wide review, and “not a reflection of Nationwide’s business model”.

The Chancellor, George Osborne, said one reason for the downgrades was that the government was seen to be “trying to deal with the too-big-to-fail problem”.

Mr Osborne said he was confident that British banks were well-capitalised. “They are not experiencing the kinds of problems that some of the banks in the eurozone are experiencing at the moment.”

Moody’s split the downgrades into three categories.

Banks with a “high likelihood of support” are RBS and Lloyds.

Banks or building societies with a “moderate or high likelihood of support” are Nationwide, Santander UK, Co-operative Bank, and Clydesdale Bank. Clydesdale’s rating was reaffirmed, not cut.

George Osborne: “They think the British government is actually moving in the direction of trying to get away from guaranteeing all the largest banks in Britain”