Europe continues to keep investors on the back foot today with Spain now vying with Greece in keeping markets nervous.

Talk that Eurozone governments were looking at withholding a €5.2bn aid payment due today due to on-going political uncertainty within the country saw markets hold their breath. The reticence is certainly understandable in the current climate with no guarantees that the money would be returned if Greece were to leave the euro.

Due to these concerns only €4.2bn has been released, with the other €1bn withheld until there is more certainty. The tone from Germany in particular was uncompromising, leave if you wish but there will be no renegotiation and no more money.
The game certainly does appear to be changing with talk of a Greek exit now being openly discussed something that would have been unheard of a year ago. For now new elections look the mostly likely outcome, as the baton moves to PASOK to try and form a government.

In Madrid fears about Spain’s banks were manifested in a sharp rise in Spanish bond yields to dangerous levels yesterday, which reflect market concern about the solvency of the Spanish banking system. In an attempt to restore confidence the Spanish government last night took a 45% stake in Bankia, by way of its bank bailout fund.

On Friday the government is expected to ask banks to set aside an extra €30bn of capital against their property assets, however there is a concern this may be nowhere no enough given the amount of distressed loans could be as much as €180bn. This sounds all very laudable but one wonders how they expect to do that when the Spanish economy is shrinking and unemployment continues to rise. The risk is that the sovereign takes on the liabilities, and with that the solvency of the sovereign then comes in to question.

Putting concerns about Spain, Greece and Europe as a whole to one side today the focus shifts towards the UK and the Bank of England rate meeting today as well as the March industrial and manufacturing production figures.

Yesterday’s sharp fall in BRC retail sales for April showed an annual decline of 3.3%, wiping out the rise of 1.3% in March, and has raised concerns about the strength of the UK economy, and the retail sector especially. It is important to remember that this decline does have to be set into the context of the timing of last year\'s Royal Wedding as well as a late Easter, and this April’s rather wet weather, with the comparatives being very unfavourable.

Even so there is an expectation in some quarters that the Bank of England could well announce an extra £25bn of asset purchases today, especially in light of the poor Q1 GDP numbers a couple of weeks ago as well as the likely disappointing March manufacturing and industrial production figures due to be announced earlier this morning. Expectations are for manufacturing to rise 0.5% and industrial production to slip 0.3%.

We’ve already seen widespread scepticism about these numbers given the fairly robust PMI data seen from both these sectors throughout the quarter, and we also saw from the latest minutes from the last Bank of England meeting that Adam Posen reversed his call for additional QE and he has been for quite some time the most dovish member of the MPC.

It would be a surprise if he were to change his mind so quickly, given the current risks with respect to the stickiness in inflation. It would seem more likely that the Bank of England will hold fire for now, until after next week’s quarterly inflation report, especially given what is happening in Europe at the moment.

EURUSD – yesterday’s drop through 1.2960 and close below 1.3000 reinforces the risk for further losses towards the lows this year at 1.2630.
For the move lower to unfold as expected we need to see the single currency stay below the triangle pullback line at 1.3060.
Only a move back above the gap at 1.3085 has the potential to stabilise in the short term and target a retest of 1.3200.

GBPUSD – the pound slid back yesterday but has so far managed to hold above the support above the 1.6050 level mentioned in yesterday’s note, rebounding from 1.6070.
Only below 1.6050 argues for a test towards the trend line support at 1.5990 from the January lows at 1.5235. Below that and we could see 1.5770 which is 50% retracement of the entire up move from 1.5235 to 1.6305.
Primary resistance remains at the trend line resistance at 1.6320 from the 2011 highs at 1.6750, as well as 1.6200, the highs this week.

EURGBP – the single currency continues to drift lower as the pound continues to benefit from the euros woes, though we did get a squeeze back to the 0.8060 level before heading towards the support area which lies between the 0.8010/20 area. A close below 0.8010/20 targets the risk of further losses towards 0.7700 over the medium term.
There remains a risk of short squeeze to fill the gap between Fridays low and the highs this week, towards the 0.8100 level, however to stabilise we would need to see a move back above 0.8140, to retarget resistance at 0.8220 and trend line resistance at 0.8260 from the February highs at 0.8505.

USDJPY – falling US bond yields continues to keep the downside pressure on the dollar here and looks like we might have to throw the bullish US dollar scenario out of the window if we can’t close above the 80.42 cloud resistance. It certainly keeps the risk skewed to the downside.
Yesterday’s break below 79.70 now targets 79.20 initially on the way to 78.35 and the 200 day MA.
The 80.42 cloud line should now act as a resistance level and for the dollar to stabilise we would need to see a close back above this key level.