Europe Divisions Continue ahead of German IFO by K. Morrison

Divisions in Europe continue to dominate as collateral becomes the latest hot topic, Finland threatens to withdraw from Greek bailout, German IFO set to fall further, Japanese rating cut to Aa3, US dollar remains under pressure ahead of US durable goods, metals extend decline.

If Angela Merkel thought trying to convince financial markets about her commitment to Europe was a tough act, she didnt reckon the intra-Eurozone divisions as well as within her own government. Finlands recent announcement that it had agreed a collateral arrangement with Greece in return for its bailout funds has prompted similar demands from other European countries. Ratings agency Moodys has warned that such arrangements are problematic and should not be adopted, and Angela Merkel has herself called for the agreement to be overturned. Finland for its part has threatened to withdraw from the bailout if it is forced to give up its agreement.

In a separate development, German labour minister called for all bailout countries to give up their gold reserves as collateral in return for bailout funds, and there now has to be a real concern that the Greek bailout could fall apart as respective governments grow concerned about pouring more money into a fiscal black hole.

Yesterdays worse than expected ZEW number was a bit of a shocker, coming in at -37, the third monthly decline in a row, and this has prompted concerns that the German economy could well grind to a halt in the third quarter. If todays IFO data for August is similarly bleak then we could see the single currency tumble quite quickly. Expectations are for current assessment data for August to slip back to 119.8 from 121.4 in July, while current expectations are expected to decline to 102.8 from 105.0. Business confidence is also expected to decline from 112.9 to 111.

Earlier this morning, Moodys cut Japans credit rating from Aa2 to Aa3 with a stable outlook, citing weak growth prospects. At the same time Japanese finance minister Noda announced a further package of measures to curb the recent strength in the yen including a $100bn emergency credit facility to help support Japanese companies. Also announced was new monitoring which requires all financial institutions to report on all FX positions held by traders throughout September.

The US dollar has continued to come under pressure ahead of this weeks Jackson Hole symposium with expectations that Ben Bernanke will announce further measures to stimulate the US economy. This belief could well be misplaced and markets could well be lining up for a major disappointment. The reality is the bar is a lot higher now, notwithstanding the different political landscape, higher inflation and divisions in the FOMC.

US durable goods for July is up in the afternoon session and investors will be hoping for an improvement after yesterdays disappointing Richmond Fed and home sales data.

Gold slid back overnight posting a key day reversal which suggests we could well see further declines in the short term, within the broader medium term uptrend.