European political worries halt risk asset rally

By Richard Hubbard

London | Mon Feb 4, 2013 11:23am GMT

(Reuters) - Stronger U.S. and Chinese economic data supported world equity markets on Monday, while the euro dipped and Spanish bond yields rose as growing political uncertainty in southern Europe worried investors.

The global economic outlook brightened substantially last week when data showed U.S. factory activity quickened in January and hiring increased, and a euro zone business activity survey suggested the worst of the region's downturn may be over.

On Sunday China said its official purchasing managers' index (PMI) for the services sector had risen for a fourth straight month in January, although its slim gain added to evidence that the global recovery is a modest one.

But in Europe the uncertainties in Spain and Italy reminded investors of the risks still ahead, dampening the positive mood and encouraging some sellers.

Over the weekend Spain's opposition Socialist Party called on Prime Minister Mariano Rajoy to resign over a corruption scandal, as a poll showed the lowest support on record for his centre-right People's Party (PP).

"If Rajoy were really forced to resign, if we were to have new elections in Spain, that would not help the improvement we've seen in financial markets," Tobias Blattner, European economist at Daiwa Capital Markets said.

In Italy former prime minister Silvio Berlusconi, one of the top candidates in this month's general election, is seeing a resurgence in popularity which threatens the reforms implemented by the outgoing technocrat government.

Spanish 10-year government bond yields rose 10 basis points to 5.32 percent on Monday while equivalent Italian yields were 9 bps higher at 4.42 percent.

The yield gains reversed the strong start to the year on all of Europe's peripheral markets which had been helped by the easy supply of cash from central banks and the promise that the European Central Bank will buy bonds of struggling states if necessary.

However, the improving economic outlook was still supporting a shift out of safe-haven German government bonds, although the yield gains were tempered by the rise in Spanish and Italian debt. German 10-year bonds were up three basis points at 1.7 percent.

The uncertainty in Spain and Italy, along with more weak Spanish employment data, also drove the euro down against the dollar.

EURO SETBACK

The common currency fell 0.4 percent to $1.3574, off a high of $1.3710 on Friday which was its strongest level since late 2011.

Analysts said this was likely to be only a temporary setback, and the euro would resume its move higher if, as expected, the ECB leaves interest rates unchanged on Thursday and does not express any concerns about the recent gains.

"Once the ECB fails to cut rates on Thursday, which is our view, the euro will be free to move higher again, but with the uncertainty surrounding the meeting the euro will likely weaken slightly or trade sideways," said Adam Myers, senior FX strategist at Calyon.

Equity markets were looking to consolidate after the strong economic data last week had taken many market benchmark indexes to fresh multi-year highs.

EQUITY RECORDS

MSCI's world equity index rose just 0.1 percent on Monday, holding near a 23-month high and a few points shy of its best level since 2008.

The FTSEurofirst 300 index of top European shares was little changed while Germany's DAX dipped 0.1 percent to 7,832 points but remained within sight of its 2007 all-time high of 8,151 points.

U.S. stocks were poised for a mixed start as well after the jobs and manufacturing data on Friday prompted buying that took the Dow Jones average above 14,000 for the first time since October 2007.

The benchmark S&P 500 index also touched its highest since December 2007 after a 5 percent gain in January, which was its best start to a year since 1997. The index is now just about 60 points away from its all-time intraday high of 1,576.09

Rising confidence in the global economic recovery was also underpinning commodities such as oil and copper, although prices moved in narrow ranges at the start of a week when several major central banks hold policy meetings.

Brent crude was 35 cents lower at $116.41 per barrel though close to a 4-1/2 month high of $117.07 reached on Friday. U.S. crude slipped 45 cents to $97.32 per barrel

"The market is long due a correction. Still, there is no point standing in front of a moving train," VTB Capital oil strategist Andrey Kryuchenkov said.

(Additional reporting by Anooja Debnath; Editing by David Stamp)