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Given the slower growth backdrop that we are seeing, both in Europe and Asia, it’s interesting to note that oil is pushing 8 month highs this week.

It also throws another obstacle into the path of the lower inflation rates that are anticipated but also very much required in Europe, allowing policy-makers to ease policy further (especially in the eurozone) and also reducing the severe squeeze seen on real incomes in many countries.

The threat of sanctions against Iran from the EU has been the main factor this week pushing prices higher.   Yesterday, this came at a time when the market was falling back on the familiar themes, which served to push EUR/USD back below the 1.30 level.

But policy makers will have to look through the short-term gyrations of the oil price and push for easier policy, the ECB especially so, because the channel to second round effects in the wider economy is very weak at this point in time.

Guest post by FxPro

Commentary

Single currency succumbs to familiar themes.    The relative calm and optimism that characterised Tuesday’s trading session dissipated, with both the euro and Swiss franc leading the charge lower in currency markets during the course of Wednesday. Markets were back into familiar territory, with Spanish bonds falling on the back of newspaper speculation (Expansion) that Spain is seeking EU/IMF help, although the government have denied such claims. The new government has been quick to use its majority to outline austerity plans and appoint ministers in an attempt to convey they mean business. Meanwhile, there was also talk of the ECB buying Portuguese bonds under their bond-buying program.   The fact that the euro broke back below the 1.30 level, together with the observation that it was the weakest currency during the European session, increases the perception that despite the new-year and the usual optimism that this brings the underlying problems remain in place. Furthermore, there are many hurdles to be overcome in this first quarter, including the EU/IMF advancing further funds for Greece (or not), together with the continued talks around private sector involvement in October’s Greece rescue deal. Finally, there is the substantial funding that has to be completed by both banks and sovereigns. There can be little doubt that 2012 will be the year that decides the euro’s fate, as muddling through becomes even more expensive and politically unsustainable.

France tests the waters.   With all eyes back on the sovereign crisis, France will test investor appetite today, with up to EUR 8 bln of bonds on offer. The decision on whether France will keep its triple-A rating from S&P looms large, with S&P likely to decide sometime this month. Whilst spreads over Germany have narrowed from the highs seen towards the end of last year, they remain substantially above other triple-A nations with the eurozone and French officials appeared to be resigned to a downgrade towards the end of last year.   As such, today’s bond offering could be one of the last with a triple-A rating in France, at least for the time being.

Falling Chinese home prices. According to the largest property website in China, home prices fell by another 0.25% last month, the fourth consecutive decline. SouFun Holdings also reported that prices dropped in 60% of China’s cities in December, including Beijing and Shanghai. Premier Wen Jiabao reaffirmed this week that the economy will endure more difficult conditions this quarter, while contending with elevated inflation at the same time. Restrictions on property lending and the sharp increase in bank reserve requirements implemented last year were both aimed specifically at taking the heat out of the property sector, a key policy objective which is now working. Beijing will be conscious that relaxing these policies too quickly could re-ignite property speculation. As such, although easier policy is definitely on the way in China, reductions in bank reserve requirements and other measures to relax financial conditions will likely occur at a slower pace than the market currently expects.