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The pound rose to a two month high against the broadly weaker euro exchange rate

The pound rose to a two month high against the broadly weaker euro yesterday on the back of stronger than expected UK construction data and persistent worries about euro zone debt contagion.

Both Italy and Spain were under fire again as investors pushed up bond yields and the cost of insuring Italian and Spanish debt rose up to record levels. The yield on benchmark 10-year Spanish bonds stood at 6.3%, while their Italian equivalent were at 6.16%. Over the last 14 months, a yield of 7% has been unsustainable and it was at this level that Greece, Portugal and Ireland were driven to accept bail outs. The worry is the sheer size of these economies. Greece, Portugal and Ireland represent together a mere 5% of euro zone GDP whereas Italy is the third largest and Italy the fourth largest economy in the euro zone. Were either of these countries to be forced to seek financial help from the euro zone there are concerns that the bail-out vehicle, the European Financial Stability Facility, would be unable to supply the necessary funds.

Sentiment, already fragile by worries about the health of the world economy after the publication of poor manufacturing data from the US and UK over the last few days was not helped by a report from the OECD that it will take Greece up to two decades to bring its massive public debt to more sustainable levels. The report also states that the European Union’s Greek bail-out plan would put little more than a dent in the country’s debt mountain.

The report makes clear the many impediments to Greece successfully dealing with it massive debt pile, which currently stands at around 140% of GDP.

As the euro came under pressure, so the Swiss franc traded sharply higher across the board as weary investors grow increasingly anxious about the global economy. The Swiss currency benefited from strong risk aversion despite the Senate approval of the US debt bill, as investors mulled another batch of disappointing US economic data and as unease about European sovereign debt risks rumbles on.

The dollar traded at an all time record low against the Swiss franc with the euro sharply down.

The dollar however made headway against most other major currencies, particularly against the euro where overnight it rose over 1.5% against the single currency.

Two credit ratings agencies, Moody’s Investors Service and Fitch Ratings have confirmed that the US will keep its prized AAA credit rating for the time being. However, both warned that they could downgrade the world’s biggest economy if politicians didn’t carry through their debt reduction plans. Late last night, President Barack Obama signed legislation to increase the US debt ceiling and avert a financial default after the Senate voted for a compromise deal by 74 votes to 26.

The deal sees the country’s debt limit rise by up to $2.4 trillion from $14.3 trillion which will be followed by savings of at least $2.1 trillion over the next 10 years.

Steven Hess, senior credit officer at Moody’s in New York, told Bloomberg that the agreement was “a positive step toward reducing the future path of the deficit and the debt levels”.

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