Euro falls on continued contagion fears

USD

The dollar pared its overnight fall after the outlook for the global economy remained clouded with uncertainty and risk appetite subdued. Earlier sentiment had improved briefly following the news that China was loosening its credit conditions, following reports that the Pboc had relaxed its reserve ratio requirements for 6 rural banks in the Zhejiang province by 50 bps. There was further speculation it might relax the requirements for all banks in Q1 2012. Nevertheless the dollar recovered after rating's agency Fitch downgraded Portugal's credit rating from BBB- to BB+. Additional fears that Germany might be infected with the debt contagion also weighed on risk appetite and supported a rise for the dollar back up to yesterday's highs. The dollar appeared to pull back again, however, as the U.S session got underway and American traders squared their positions ahead of the Thanksgiving weekend holiday. On the economic docket there was no data out on Thursday.

EUR

 The euro started the day higher after reports from China that that it was loosening its banking regulations and this encouraged a more optimistic macro economic outlook. Risk-on soon gave way to risk-off however as euro-zone debt concerns returned to the fore. Rating's agency Fitch downgraded Portugal from a BBB- to a BB+ on the day of a general strike there. The euro was further pressured by fall-out from the unsuccessful German bund auction on Wednesday which saw a substantial rise in borrowing costs and stoked fears the contagion had spread to Frankfurt. Politicians continued to offer messages of assurance but they continued to diverge on the subject of eurobonds which also received considerable attention. The President of the E.C Manuel Barrosso made a presentation on eurobonds with 3 different types of proposed implementation - one a blanket swap and replacement for all 17 countries of their bonds with eurobonds, two a 60% of GDP cap on eurobond issuance per nation which would have to back further issuances themselves and finally a much more tempered guarantee system in which members kept all existing arrangements but would begin guaranteeing eurobonds in parallel. However, as usual Germany objected to the idea with Chancellor Merkel describing it as "extraordinarily inappropriate" for the commission to "overcome the shortcomings of the currency union's structure by collectivizing debt." On the data front German business sentiment gauge IFO dominated and showed a rise, with Current Assessment at 116.7 vs 115 expected and Business Climate at 106.6 vs 105.5 expected. Other data showed German GDP flat lining at 2.6%, which reinforced a negative outlook for the region.

GBP

The pound pared the overnight bounce after a shift in market sentiment followed more bad news from Europe and led to sell-off in riskier assets. Analysts believe sterling could drift lower in the days ahead as the BOE grows increasingly cautious about the U.K economy. Ben Broadbent was the latest BOE official to make dovish comments as he warned of the threat of the U.K falling into a double dip recession. In light of previous comments from Martin Weale and others who advocated the use of quantitative easing the possibility of more action seems likely. U.K Gilts held up impressively on Thursday when they bore lower yields to equivalent German Bunds but this failed to stimulate increased interest in sterling. It is possible the currency failed to garner safe-haven support because of its exposure to the euro-zone. Growth fears continue to weigh on the British pound despite some signs of encouragement. On the data front 3rdquarter GDP revisions remained unchanged at 0.5%, Private Consumption fell to 0.0% versus 0.2% expected; Government Spending rose by 0.9% vs 0.5% estimated; Gross Fixed Capital Formation fell by -0.2% vs 1.1% expected; Business Investment slowed down in Q3 to 0.3% rise versus the 3.8% in the 2nd quarter.; finally Exports fell -1.0% versus 0.8% expected in Q3 and CBI Trends Total Orders for November came out at -19 as forecast.

JPY

 The yen rose on Thursday as risk aversion renewed its grip on markets following a worsening outlook for the euro-zone. Despite news from China leading to a minor recovery in risk sentiment ?after the Pboc relaxed reserve ratios for some banks, most of the day saw a resumption of the risk selling and the Japanese yen stood out as the outright beneficiary. There was also dovish commentary from a director at S&P ratings who said in an interview that Japan's finances were getting worse even though deterioration had been gradual so far. He added that the Rating's agency was close to a downgrade. On the data front there is a raft of releases covering inflation with Tokyo CPI expected to remain at -0.5% and National CPI expected to dip to -0.2% from 0.0% in the previous month of October. If expectations are met it will continue the deflationary spiral down –and likely offset the current phase of strength against the dollar, since it would indicate a persistence of the current low-yield environment compared to the dollar; making the yen the less attractive safe haven from that standpoint.