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The euro view

We are seeing both the euro and Aussie weaker at the start of the European session as FX markets react to the latest pronouncements from central banks and officials. For the euro, Governing Council member Mersch was the latest to lead markets into expecting policy action at the June meeting and this has added to the negative backdrop to the single currency.  But the question is whether policy action from the ECB is going to have a sustained effect on the euro, because the options available to them are likely to be of limited impact. The alternative view of the euro is that portfolio flows are what matter more, investors being attracted to European bond and equities. The rally in peripheral bond markets so far this year has been a factor in keeping the single currency firm, which is why the latest correction, which has seen Italian 10 year yields move up from 2.75% to 3.15% (with similar moves in other markets) is worth keeping a close eye on.

For today, inflation data in the UK takes centre stage. The market expects a move up to 1.7% (from 1.6%), although there is some risk that we could see a firmer number would give some added support to sterling. The issue is whether the reasons the Bank expects inflation to remain relatively well behaved are going to remain valid. Last week there was a strong focus on the level of slack in the economy keeping inflation in check, so think of unused factories, unemployed labour, but this is a very difficult thing to measure and the Bank has been wrong before on this in the early part of the financial crisis (thinking that this would pull inflation lower). We have the MPC minutes tomorrow and it could well be the case that we start to see more dissent among the committee in the coming months.  Finally, note that the Aussie is weaker on the back of the latest RBA minutes, which suggest the central bank is looking for slower growth on the back of the recently announced fiscal tightening.

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