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Fundamental Afternoon Wrap: Markets overlook Cypriot shock as Italy and UK jostle for limelight

FXstreet.com (Barcelona) - This afternoons institutional research has seemingly designated the Cyprus issue to the back of the list, with Italian politics again pushing forward to the front of the queue for attention. Elsewhere, GBP remains in focus with a busy week for the UK, with CPI tomorrow, BoE minutes and the 2013 Budget.

EUR

Michaela Moran of BAML believe that even if Italy fails to form a government, leading to a seizure of bond purchases, the ECB still has room to maneuver. She sees two scenarios, an unstable equilibrium and the other a stable one. She writes, “In the unstable equilibrium the ECB would provide liquidity to banks renewing the 3y LTRO. In the stable equilibrium the ECB would proceed with bond buying, together with a move to greater political union in the wake of that debt mutualisation through the ECB.” Looking to the Italian parliament, she adds that today is the first day of the new parliament. She writes, “Key event to watch is the formal initiation of coalition negotiations by President Napolitano on 19 March. In our view, it remains a close call between a semi-technocratic government largely supported by the left and Five Stars, or another election soon.”

Meanwhile Brown Brothers Harriman analysts believe that the reaction to the Cyprus story was exaggerated and the market spent the Tokyo afternoon and the European morning retracing the initial moves. they add that the Cypriot parliament had been expected to vote today at 14:00 GMT on a new proposal that will have a more progressive tax on depositors, but some local media reports suggests the vote may be delayed. They add that the most biting criticism of the Cyprus package is about the principle, not simply the amount of the tax on small depositors. Rabobank analysts note that CFTC shorts have declined modestly despite the better tone and ongoing uncertainties connected with the Italian election result and the news that Cypriot depositors may be taxed as part of the island’s bailout should keep the EUR on the back foot.

GBP

Michaela Moran of BAML believes that with sterling having fallen by around 6% since the start of the year, she thinks CPI inflation could continue to climb higher. Further she adds that the Chancellor's Budget statement next week could have implications for both monetary and fiscal policy. She wriites, “He should be relatively constrained with fiscal policy, and any unexpected loosening would likely raise the probability of a downgrade and weigh on gilts. A change to the monetary policy remit - increasing the probability of looser monetary policy - would be negative for sterling while raising inflation expectations.”

Brown Brothers Harriman analysts notes that the UK will command the markets attention this week with Tuesday's CPI, a warm up before the midweek flurry of the employment report, BOE minutes and Chancellor Osborne's budget. They note that many commentators are expecting the Government to ease up on its austerity policies, but they feel that this massively misunderestimates the political capital invested by the Cameron government in its current policies. Meanwhile Rabobank analysts note that Sterling’s decline made further progress and this week the UK budget threatens to bring further negative news. They write, “CFTC Shorts are at their most significant since October 2011.”

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