UK and Netherlands in Focus

The US dollar is mostly softer today, despite the Fed's Kocherlakota clearly joining the less dovish camp that says no more accommodation (read QE3) is needed.  The euro extended yesterday's recovery to trade at new highs since March 8. 

We had anticipated the euro moving into the $1.3250-$1.3300 range after the $1.30 support held last week.  We are hesitant to chase the market at these levels, especially with the 2-year interest rate differential (US-Germany) recovering to 7 bp from 2.5 at the end of last week.  The change is often more important than the absolute level. 

Concerns about the slowing of the Chinese economy (PBOC cut required reserves today for some agricultural banks, as it seeks to boost rural lending) and cross rate adjustments have weighed on the Australian dollar.  The euro is making new highs today for the year against the Australian dollar as the momentum traders now sense they have the shorts (short euro long Aussie) positions on the run.  This has frustrated our constructive tactical outlook for the Aussie.  

The UK is in the limelight today.  First, the BOE minutes surprised expectations.  With the current gilt purchase plan being implemented, few expected the doves Miles and Posen to push for additional gilt purchases, but they did, resulting in a 7-2 vote instead of a 9-0 vote.  Sterling had made a marginal new high for the move, poking briefly through Monday's high near $1.5915 to almost $1.5925 today before the minutes which saw sterling quickly drop to session lows near $1.5840. 

Second, the UK's budget deficit nearly doubled in February as tax revenues fell and spending increased.   The net borrowing of GBP15.2 bln was the largest shortfall in February on record.   In the first 11 months of the fiscal year, the UK deficit is GBP110 bln vs GBP119 bln in the same year ago period. 

Third, next year's budget will be proposed shortly (~8:30 EST).  Details have largely been leaked.  The general thrust appears to be a compromise between the LibDems who seek a income tax break for households and the Tories who want to more business friendly.  Growth forecasts are likely to be tweaked higher to 0.8% from 0.7% as well.   Barring a major surprise/disappointment, sterling can retest the highs and looks poised to recover against the euro. 

News that the IMF seeks another 12 bln euro in savings from Greece to be detailed in the next three months and that Portugal's core public sector deficit in the Jan-Feb period was almost 800 mln euros compared with 275 in the Jan-Feb 2011 period keeps the peripheral in focus. 

However, it is the Dutch bonds today that are under pressure.  The Dutch benchmark yield is up 5 bp today, the largest rise among core bonds and matches the rise in Portuguese benchmark yield, but as Portugal does not need to issue bonds this year, the Dutch yield is more telling.   

Yesterday report by the Dutch analytic bureau  was even less sanguine about reaching the deficit targets than previously.  It revised its deficit estimate to 4.6% for this year and next; a slight tweak from its previous 4.5% projection, but illustrates its confidence of the miss.   It forecasts a 0.75% economic contraction this year.   The government needs to find another roughly 9 bln in savings, but the seemingly fragile coalition is struggling to do so.