With the positive impact of the news that Italian PM Silvio Berlusconi is to step aside quickly wearing off, risk aversion spiked higher once again yesterday. A jump in 10-year Italian bond yields well above the 7% level that many consider unsustainable caused investors to move into safe haven assets such as the USD. As well as the rise in yields, the news that clearing house LCH.Clearnet had raised its initial margin requirements on Italian bonds, making the market more expensive to trade also hit sentiment.

Under heavy selling pressure for much of the day and overnight, the euro fell over three cents versus the USD before steadying in early morning trade but downside risks remain. Sterling, the AUD and a host of other risk sensitive currencies also suffered losses. However, with the euro underperforming, the GBP moved higher against the single currency. Eastern European emerging market currencies such as the Hungarian forint also fell back in line with the euro and are expected to remain under pressure near term.

Also adding to negative sentiment are ongoing political turmoil in Greece, with the national unity government still not formed, as well as comments from the German government’s Council of Economic advisors that a break-up of the euro cannot be ruled out if member countries don’t repair their budgets. Meanwhile, the mood is unlikely to be helped by today’s release of the latest set of European Commission’s economic forecasts, which are expected to show downgrades to the 2012 growth outlook. With the attention remaining firmly on Europe, there is likely to be little focus on today’s policy decision from the Bank of England, which is expected to leave policy on hold anyway.

For Euro buyers this isnt a bad time to cover positions, Euro sellers should be cautious of further selling going forward. The higher yielding currency pairs also offer a good buy, the AUD and NZD are both down following selling on the stock markets over the last couple of days. GBP/USD still trades close to the key 1.60 psychological level but gains seem capped at 1.6130.