Risk aversion dominated the markets yesterday

Yesterday saw a correction to the markets seemingly relentless rise in risk appetite since the turn of the year with big sell-offs in the world stock markets triggering a wave of risk aversion. The dollar was the main beneficiary, making substantial gains across the board.

In the UK, the Markit/CIPS service sector index rose from 48.9 in December to 51.5 in January, well ahead of projections showing a strong start to the year for the services sector in the UK.

The highlights of the report include the best gain in employment for six months for the services sector and the highest business confidence level since May 2012.

David Noble, Chief Executive Officer at the Chartered Institute of Purchasing & Supply, commented that “Revivals in 2011 and 2012 dissipated pretty quickly, so firms will be hoping this is third time lucky and a stable foundation for growth.”

Chris Williamson, Chief Economist at survey compilers Markit said “A huge sigh of relief accompanies these numbers, as a return to growth of the service sector in January greatly reduces the likelihood of the UK falling back into a “triple-dip” recession.”

Ahead of the latest euro zone summit, due at the end of this week, French Premier Francois Hollande told the European Parliament that there could be no “a la carte” attitude to the EU in a dig at British prime Minister David Cameron’s plans to hold a referendum about EU membership in 2017 should the Conservatives win the next general election.

Hollande also insisted that the euro zone defend an exchange rate policy that protects the single currency from irrational price swings saying "Europe […] is leaving the euro vulnerable to irrational movements in one direction or the other. A monetary zone must have an exchange rate policy or else it ends up subjected to an exchange rate that does not match the true state of its economy."

Hollande’s comments come on top of comments from Luxembourg premier Jean-Claude Junker voicing concerns that a strong euro in relation to other countries makes exports too expensive for euro zone members, lowering demand for European goods and services that in turn hurt the economic recovery in the area.

Yesterday, Markit also reported that euro zone economic activity continues to show a further deterioration in output, albeit with the rate of decline easing in January for the third month in a row.
Both the euro zone's manufacturing and service sectors declined at the slowest rates since last March, even though the data came in below the 50 mark that implies a contraction.

Of concern, the data continues to accentuate the idea of a European economy running at two speeds, or as Markit notes “the diverse picture among the four largest euro members with strong growth in Germany (where output grew at the fastest rate in just over a year and a half) contrasting with ongoing downturns in France, Italy and Spain.”

Output in France registered the steepest drop, with the fastest monthly decline since March 2009 “causing the gap between the headline indices for France and Germany to increase to the widest in the survey history.”

Markit chief economist Chris Williamson commented that “the euro zone is showing clear signs of healing”, although he admits that the growth is “heavily skewed” towards Germany.

The end of this week should provide some additional fireworks as in addition to the latest EU summit, we have policy announcements from both the Bank of England and European Central Bank and Thursday see's the testimony by Bank of England Governor-in-waiting Mark Carney before the Treasury Select Committee.