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When everything, everywhere is in turmoil, where do widows and orphans look for security? Safe havens are beseiged by storms, and even gold is on the slide. Suddenly, investors are turning up their noses at the Swiss Franc and the yen. Meanwhile, the U.K. pound is being battered. It lost five cents against the euro in a mere two weeks, bottoming at its lowest level against the single currency for more than a year.

Only last summer, Sterling was the pampered pet of the currency market, with massive capital inflows into London from the troubled Mediterranean economies of the euro zone. The flow has suddenly reversed and cash is flying out of U.K. banks seeking the high yields offered by Spanish and Italian government bonds. This morning, the Spanish government published some miserable data: the economy shrank by 1.8 per cent in the final quarter of 2012. A quarter of the Spanish workforce is looking for a job and yesterday, figures from Spain's main street showed the impact on spending, with retail sales down 10.7 per cent over the Christmas period.

But the capital markets seem to be oblivious to – or just bored of – gloomy news, and Spanish government bonds are in demand: yields have fallen to just over 5 per cent from close to 8 per cent last summer. The buzzy notion is that the apparent appetite for more risk and higher yields is an indication that investors think the euro zone crisis is over, and that the smart money is catching the train as it leaves the station.

The question everyone wants to know is whether this train is on the main line or heading into a siding. The European Central Bank's decision last year to lend to the battered banks of the Club Med effectively drew a line in the sand: The markets are not prepared to bet against the ECB. Logic dictates therefore that the capital flight from the euro zone was overdone, that a sovereign bankruptcy is not imminent nor even likely in the short to medium term. A correction was due and funds have quickly shifted to take advantage of some cheap sovereign income.

Meanwhile, governments and central banks around the world are chasing growth. Japan set the tone with a massive stimulus package and there is talks of currency wars or competitive devaluations. Mark Carney, the incoming governor of the Bank of England, helped to stoke the flames a little at the World Economic Forum in Davos when he seemed to suggest a loosening of monetary policy was in order.

Loose talk, especially snapping at the heels of the outgoing and more hawkish governor Sir Mervyn King, was a good enough signal to speculators waiting for a chance to trash Sterling. The British pound always looked a poor excuse for a safe haven; a big budget deficit, a stuttering economy and a politically weak government is not the recipe for a strong currency.

Yet the question remains whether this massive movement of money means that Europe is set for recovery; the answer cannot yet be a resounding "yes." The markets are now willing to lend to Spain, but a stronger euro will make a euro zone export-led recovery more difficult, not less. What we are seeing is a readjustment; the markets have accepted that Germany is not prepared to abandon its weaker euro zone partners. For the time being, politics has trumped markets, but the politicians should be aware that the markets will test them again.

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