The euro rally continued in early European trade today after the IFO survey of business confidence handily beat expectations printing at 83.7 vs. consensus calls of 82.1. The IFO release was the third positive economic surprise from the EZ this week, following on the heels of better ZEW and PMI data numbers. As a result the EUR/USD has rallied more than 300 points off the week’s lows as short covering continue unabated.

The IFO survey of business expectations printed much better than expected confirming other data points from the Eurozone this week that showed a possible turn to the upside in the region’s economy. The IFO survey recorded a reading of 83.7 versus consensus expectations of 82.4. More importantly the Current Assessment figures improved to 83.6 from 82.7 the month prior.

The euro received a lift from better than expected PMI Manufacturing and Services surveys both of which printed materially stronger than forecast. The Manufacturing PMI rose to 36.7 from 34.7 eyed while the Services survey jumped to 43.1 from 42.1 projected. As we noted earlier, “Today’ s upward surprise should take some pressure off the ECB in the near term. European monetary authorities have come under enormous amount of criticism for keeping credit conditions too tight at a time when the rest of the G4 has implemented a near Zero Interest Rate Policy. The uptick in the PMI data suggests that the EZ economy is responding to a pick-up in global demand despite relative lack of fiscal and monetary stimulus.”

EZ PMI Services survey registered it best reading in six months printing at 43.1 versus forecasts of 41.2 while the Manufacturing gauge also improved to 36.7 from 33.9 the month prior. The better than expected results of the survey suggest that the contraction in EZ economy may be bottoming out having reached its nadir in Q1 of 2009.

After a brief pop in Asia EUR/USD selling continued in early European trade with the unit pressured by the release of yet another disappointing Industrial Production report which showed a drop of -2.3% versus -2.5% forecast. Although the data beat estimates slightly it nevertheless confirms the notion that the manufacturing sector is contracting sharply and will likely drag the EZ GDP lower as the year progresses.

After posting a tiny rebound the month prior Eurozone Retail Sales turned negative in March posting their second monthly decline this year. EZ March Retail Sales contracted by -0.6% versus forecasts of -0.3% - their worst reading since December 2008 - as European consumers fearful of rising unemployment continued to curb their spending.

Currencies spent the last working day of the week in generally listless trade until comments by German Finance Minister Peer Steinbrueck roiled the market sending EUR/USD sharply lower in early morning Frankfurt session. Mr. Steinbreuk noted that euro was at risk if the EU's Stability and Growth Pact isn't taken seriously.

High beta currencies enjoyed a rally for the second night in a row boosted by further gains in equities and continuation in risk appetite. Carry flows were once again the dominant theme in Asian trade with USD/JPY rising to 98.40 while many the yen crosses reached their highest levels since last October. The Nikkei followed through on the nearly 500 point gain in the Dow rising 272 points but the gains on the European markets were decidedly more modest with most indices barely above break even.

German and French PMI readings improved for the first time in months suggesting that that vicious contraction in demand that dogged the region over the past year may be showing nascent signs of stabilization. German Manufacturing PMI printed at 32.2 vs. 31.9 eyed while the Service PMI rose slightly to 41.7 from 41 forecast. The French data was better with services rebounding to 42.9 from 40.2 expected and manufacturing registering a reading of 36.3 versus 35 called. The EZ Composite PMI number also rose to 40.1 from 39.2 the period prior.

The EUR/USD regained the 1.3000 handle on early European trade after the ZEW survey of investor sentiment printed better than forecast. The ZEW for the month of March came in at -6.5 versus -12 forecast as investor sentiment improved for the fifth month in a row, The data was somewhat surprising given the dour state of conditions in EZ industrial sector, but clearly investor optimism was driven by hope that the massive fiscal and monetary stimulus put in place by most of the G10 block will soon begin to yield dividends and revive global demand.

Trade data from both Germany and France printed worse than expected suggesting that Eurozone economic output figures will likely prove to be weaker than the current government estimates. German Trade Balance recorded a 8.3 Billion euro surplus less than the 10.0 Billion number that the market was expecting while French data showed a deficit of -4.5 Billion against forecasts of -3.0 Billion.

Euro was lower in early European trade today dropping below the 1.2600 level ahead of the ECB rate announcement with market participants anticipating a 50bp cut in overnight rates to 1.5%. Traders were also eager to listen to Mr. Trichet’s post announcement press conference for any clues to future policy moves. In the past week a variety of ECB officials have hinted that the central bank may change its focus away from interest rate policy and towards quantitative easing.

Both the euro and pound gapped lower in Asia at the start of weekly trade after a disappointing EZ summit failed to come up with any coordinated solution to the growing Eastern European debt problem which threatens many Western European banks. With nearly $400 Billion of consumer and corporate Easter European debt, most of it denominated in euros and Swiss francs, due to be rolled over this year, EZ financial institutions face a specter of massive loans defaults unless some sort of a restructuring deal is reached.

The EUR/USD gave up much of yesterday’s gains in Asian and early European trade as risk aversion and woeful PMI flash readings kept the unit under pressure for most of the night. UK data on the other hand registered another upside surprise keeping pound within reach of the 1.4300 figure.

Tomorrow’s ECB rate announcement due 12:00GMT is shaping up to be one of the key events in the central bank’s ten year history. With Euro-zone economy facing one of the worst economic slowdowns in decades Mr. Trichet and the governing council are under enormous pressure to abandon his ”Bundesbanke-like” rhetoric and begin to ease aggressively.