Markets Overview: (Source: Bloomberg, FT, Reuters, DJ Newswires)

UK 100 called to open +35pts, advancing after a volatile round trip yesterday fuelled by low volumes and holidays (US and continental European markets closed. A positive lead has been given by Asia overnight, with optimism regarding China’s policy easing to boost its slowing economy overshadowing concerns over Europe’s debt crisis.

Traders likely to remain cautious, however, with Spain’s now toxic banking sector in a perilous state (close to insolvency? More banks bailouts required?) and Spain itself seeing its benchmark borrowing costs rise to a dangerous 6.5%. Remember that levels of 6% are considered unsustainable, while 7% has seen Greece, Ireland and Portugal require bailouts. Talk of contingency plans by banks and nations for a Euro exit also continue to concern.

Can Spain even afford to bailout the sector? The interconnectedness of the banking sector (“you’re only as strong as your weakest link”) and the amount of sovereign debt on bank balance sheets is what is keeping sentiment in check. Spain is now looking at giving sovereign debt (which it can’t sell in the market) to its troubled Bankia, for the bank to pass it on to the ECB, which would have to accept it as collateral and exchange it for funds. Financial ingenuity at its best. The trouble is that’s what got us into some of this crisis.

Sentiment improved on Greece with pro-bailout parties looking to have enough support to form a coalition after June’s second election and several banks which had been cut from ECB assistance have regained access to funding keeping them on life support. Capital outflows remain a concern, as is the case in Spain.

Swings in optimism/pessimism on Europe seeing EUR benefit and suffer versus USD, which is leaving commodities in a their tight 3-day range.

Overnight macro data saw Japan’s unemployment rate increase and retail trade slow, however, household consumption didn’t slow as much as expected. In Europe this morning, German import prices were softer than expected, something which makes goods cheaper to domestic consumers but may contribute to inflation which could impact any move by the ECB on rates.

Markets likely busier today as Europe and the US return after their holidays, but watch out for UK Retail trends data (expected to worsen), German consumer inflation (flat?), US Housing (improved?) and US consumer sentiment (improved?).  All have the potential to impact sentiment which currently sits on a rather sharp knife-edge.

Overnight Macro Data: (Source: Reuters/DJ Newswires)

• Japan               Jobless Rate                            Worse
• Japan               Household Spending               Better
• Japan               Retail Trade                            Better
• Japan               Small Bus Conf                        Declined
• Germany         Import Price Index                  Better
• Swiss                UBS Consumption Index          Improved
• See calendar for all details

UK Company Headlines: (Source: Reuters/DJ Newswires)

• Brewin Dolphin underlying profit drops, says cautiously optimistic
• BG Group confirms deal to sell Comgás stake
• Genel Energy says Ber Bahr 1 well drilling inconclusive
• Volex profit +23%, raises dividend
• Wolseley third-quarter profit +10.3%
• Cobham wins £31m service contrat with Santos
• De La Rue profit up, order book rises
• Topps Tiles – H1 adjusted profit before tax £5.6m
• Pennon full-year profit rises
• Gulf Keystone updates on Ber Bahr-1 well
• Circle Oil to raise £47.5m

Morning Press Selection:

• Euro slide could bring timely fillip – FT.com – EU Economy http://on.ft.com/JQ62Il
• Spain says help not needed to save banks – FT.com – Financial Services http://on.ft.com/MSzkfH
• Bad bank can work for Spain, says Nama – FT.com – Banks http://on.ft.com/K5nVIQ
• EU voters give thumbs down to integration – FT.com – Brussels http://on.ft.com/L9UgdB
• Commerce: Tempestuous trade winds – FT.com – Analysis http://on.ft.com/L9Ukdi
• Eurozone’s ties that bind grow tighter – FT.com – Markets http://on.ft.com/LMFnAf
• Funds cut exposure to eurozone banks – FT.com – Capital Markets http://on.ft.com/LxgMjo