Markets surge but will Italy prove too much?

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The markets’ losing streak had to be broken at some point and yesterday it was done in resounding fashion. Equities in Europe and the US pushed higher by as much as 4.5% yesterday as some confidence returned to the bourses, despite a lack of credible policy and continually poor bond auctions.

The reason behind the rally remains unclear, but we believe that is a simple combination of value investors buying up shares that have capitulated in the past 10 days or so and a hope, more than an expectation, that the European leaders will come up with something at the next EU summit due in 10 days’ time. There were mentions of a joint German and French plan to stabilise and enforce budgetary controls in the EU, however that seems to have faded out over the course of the day.

Risk remained higher as well despite the latest semi-annual report from the OECD that showed that the independent think tank believes that Europe and the UK are set for a double-dip recession -- and that is without the Eurozone blowing up! A complete deterioration in the EU is not their central forecast however it would trigger a global recession worse than 2008. They also believe that central banks should continue to keep monetary policy loose (low interest rates and quantitative easing) through 2012 and expect the Bank of England will bump QE higher in February by an additional £50bn.

All in all, the Autumn Statement from Chancellor George Osborne is likely to be a solemn affair. We already know about the credit easing plan to supplement bank loans to SMEs to the total of £20bn and the launch of an infrastructure fund to boost Britain’s roads, railways and such. The hope is that this will boost our attractiveness to investors with money (Hi Beijing!). The fear, however, is that the joint publication of the Office of Budgetary Responsibility’s latest set of expectations for the UK economy will be the second set of figures to show the country slipping into a double-dip recession. Sources who have seen the numbers pre-publication have labelled them as “shocking” and that “the light at the end of the tunnel is fading”. As such we believe sterling could be in for a tough day today. The Chancellor takes to the Dispatch Box at 12.30 GMT.

Ratings agencies were back in the news overnight as Fitch decided to leave the US’s credit rating at AAA although they did cut the country’s outlook to negative i.e. that a ratings cut may be made soon. The basis of their concern was the so-called Super-Committee’s failure to come to an agreement over a deficit reduction plan last week. In Europe, La Tribune is reporting that France may be put on a negative outlook within in the next 10 days unless a plan to deal with the Eurozone’s debts are struck.

Before the Chancellor speaks we have news from Europe in the form of a massive bond auction from Italy. Yesterday’s auction saw borrowing costs increase once again with 2-year inflation linked paper going for a huge 7.3%. The auctions today total EUR8bn and although we expect demand to be high as traders hope to offload to the ECB later on down the line, the yield is almost certain to stay at unsustainable levels. The term of this debt is also much more long-term (maturing in 2014, 2020 and 2022) and therefore would leave the country with a larger interest bill for longer. That is due just after 10am.

We also have Eurozone (10am) and US (3pm) consumer confidence numbers today, while it was reported this morning that UK house prices rose by 0.4% in November compared to the month previous. This update is signing off on either a positive or a negative depending on your stance in this housing market!

Indicative Rates Sell Buy
GBPEUR 1.1618 1.1645
GBPUSD 1.5500 1.5524
EURUSD 1.3325 1.3348
GBPJPY 120.76 121.03
GBPAUD 1.5584 1.5607
GBPNZD 2.0488 2.0516
GBPCAD 1.6019 1.6049
NZDUSD 0.7558 0.7578
GBPZAR 12.92 12.97
USDZAR 8.3296 8.3583
GBPPLN 5.2391 5.2688
EURJPY 103.86 104.13

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