Euro Reaches 1.25 on QE3/Merkel Hopes, All Eyes on RBA

Small signs of compromise from Merkel and growing speculation about QE3 boosted EUR/USD to 1.25 on Monday. Euro bounce ignored Standard & Poor's announcement that there is "at least a one-in-three chance of Grexit in the coming months, following this months elections The yen was the laggard in a relatively quiet session. All eyes shift to tonights RBA decision with the possibility of a 25 bps cut a 50 bps cut or no change. Ashraf expects a 25-bp cut, due to the deepening deterioration in all of the Aussie's PMI surveys well below the 50s, with an announcement to keep the door open for further easing this year. See more on this below.

The German press reported that Merkels coalition is prepared for some type of burden sharing in Europe. Officials appear to be moving toward making the ESM available for direct bank recapitalizations as a solution to the credit crunch in Spain. The ECBs Nowotny endorsed this type of arrangement, which has been called a banking union.

The euro climbed marginally above 1.25 from 1.2440 at the start of US trading on the signs of compromise.

USD/JPY made a small gain to 78.40 from 78.20 despite the downbeat news. The rebound was likely a function of a bounce in Treasury yields after a deep fall late last week.

Pre-RBA Analysis

An exciting week of central bank decisions begins at 0430 GMT with the RBA decision. The market is pricing in a 63% chance of a 50 bps cut and a near certainty that rates will be lowered 25 bps. Economists arent as convinced. Bloomberg surveyed 27 forecasters and 11 call for no cut, 12 for 25 bps and just 4 for 50 bps.

The knee-jerk reaction to a 50 bps will be to sell AUD while no cut would spark a rally. Those moves are likely to be lasting. A 25 bps cut may spark a small initial AUD bounce but the rest would rest on the statement. Look for commentary on China and inflation to be the drivers.

AUDUSD shorts from last weeks Intermarket Insights remain in progress. This mornings Intermarket Insights titled "Euro Rebound or Consolidation?" include trading ideas on EURUSD, USDCAD, , GBPUSD and gold. For direct access to today's Intermarket Insights, click here: http://ashraflaidi.com/products/sub01/access/?a=643 ; Non Subscribers can join here: http://ashraflaidi.com/products/sub01/

-AB