European markets stammer ahead of critical event risk

European stocks retreated overnight with residual optimism from Friday’s EU Summit seen in previous sessions no longer a key market directive. Investors have also begun to recalibrate positioning ahead of key event risk with both the ECB and BoE policy decisions due this evening. Liquidity was light as U.S Markets were closed for Independence Day celebrations.

In economic news, final revisions for German PMI (Services) fell into contraction territory with the index falling to 49.9 in June against previous estimates of 50.3, while Euro-Zone retails sales slid 1.7 percent in May from a year earlier. Although the monthly figure outpaced expectations, downside revisions for April negated any positivity with a more moderate annual decline of 1.0 percent expected. While countries such as France, Ireland, Portugal and Spain performed well, the finer points of the data showed sales from Europe’s largest economy Germany fell 0.3 percent in May.

Peripheral bond yields crept higher with Spanish 10-yr yields moving back above 6.3 percent ahead of tonight’s auction of 3 to 10-year debt. This auction is considered a critical test of confidence following last week’s EU Summit accord to allow Spanish banks to recapitalize directly through designated rescue funds. Reports of delays to Spain’s EUR100 billion banking bailout also kept the balance of risk on the side of caution.

In response to the aforementioned factors the Euro resumed a controlled decline below previous support of 1.2550 before buying activity just above the figure contained further losses.

Across the Chanel, UK Services PMI also came in on the softer side of expectations with a reading of 51.3 from a previous 53.3. Economists expected a moderate decline to 52.9. Sterling maintained a downward trajectory ahead of the Bank of England policy decision this evening. At the time of writing cable is trading at $US1.5590 with support at 1.5570 expected to contain short-term losses.

With inflation significantly lower from its peak of 5.2 percent in late 2011, it’s expected the Bank of England now have the ample breathing space to step-up easing measures with another £50-75 billion expected to be added to their quantitative easing tally at tonight’s meeting. June’s policy meeting minutes show the committee expects further moderation in consumer prices as energy and import costs continue to ease. While the committee decided to wait for key events to play out in Europe, the minutes showed a strong case to expect further easing in the near-term. Inflation data released after the last BoE policy meeting showed further moderation in price pressures with headline inflation dropping to an annual pace of 2.8 percent, while core prices moved slightly higher to 2.2 percent but less than the 2.3 percent expected. Now market participants have sufficiently priced-in the chances of further quantitative easing, this suggests sterling will be governed by either how much they extend the asset purchase program or indeed if the Mervyn King and the committee unexpectedly decide to remain on the sidelines. Interest rates are expected to remain on hold at 50bps.

Key data domestically will see the release of trade balance data for May which is expected to show the trade deficit widened to A$500 million from a previous deficit of 203 million. Diverging demand between the Euro and Aussie dollar remained in play, with the EURAUD pair now eying euro-era lows set in February. The pair is currently trading at 1.2185 off overnight lows of 1.2169. The AUDUSD pair has lost moderate ground overnight but maintained a tight 40-pip range. At the time of writing the local unit is buying 102.7 US cents.