Markets brush off Europe's fumbling response to Cyprus crisis
25/Mar/2013 • Currency Updates•
European authorities’ handling of the Cyprus bailout set a new low. The initial agreement to force losses on all depositors and ignore the 100,000 euro deposit guarantee unravelled very quickly amid popular resistance. Markets, however, are clearly confident that the crisis is a one-off due to Cyprus small size. Neither the euro nor peripheral spreads moved very much, and the common currency actually rose slightly for the week. Equities and commodities eased slightly, in a remarkably undramatic week for markets.
The main news in the UK was the release of the Budget. There were no significant shifts in the overall fiscal stance from what was expected, save for a modest easing in employer taxation towards 2014, and some equally modest housing schemes. Nothing in the Budget, therefore, changes our view that the economy will show at best anaemic growth in 2013, and therefore the MPC will increase the Gilt purchase target soon. While data on employment and retail sales did show a modest improvement last week, we think that the serious weakening in European activity (more on that below) will carry more weight with the Bank of England, and expect the target to be raise by another 50 billion GBP by the summer. Sterling more or less ignored the Budget release and ended the week close to unchanged against most major currencies.
The euro managed to post an impressive performance, ending up slightly higher against the dollar in spite of the relentlessly negative news. The ‘troika’ completely mishandled the Cyprus crisis. The initial bailout package, containing levies on all depositors and ignoring Europe’s 100,000 euro guarantee (agreed to back during the Lehman crisis in 2008) was rejected by the Cypriot parliament, but not before spooking depositors and causing runs on Cypriot banks that could only be contained by closing the banks. Overnight the ‘troika’ were able to hammer out a second bailout agreement which aims to protect smaller depositors whilst ensuring that the Cypriot banking sector remains liquid.The bailout accord will see Cyprus Popular Bank Plc wound down, wiping out bondholders, and will also impose losses on some depositors at Bank of Cyprus Plc. Whilst depositors with under 100,000 deposited will be guaranteed, larger depositors will be liable to a 40% one-off tax. The euro traded higher this morning on the back of the news of the 10 billion euro bailout. However, strict capital controls are certain, as the only means of keeping the banks functioning, and therefore Cyprus has de facto a new, non-convertible currency. Cyprus is indeed too small (0.2% of European GDP) to have much direct impact, but we think that what it has revealed about the extreme weakness of European institutions and decision making is significant. The Cyprus crisis overshadowed a dismal week of macroeconomic releases. The PMIs for March fell sharply to 46.5, and these polls were conducted before the Cyprus crisis. The surveys fell across all major countries, with France being a new worry at a dismal 42. All in all, we do not share the market’s complacency about the dismal European prospects nor its institutional weaknesses, and expect the weakening trend in the euro to continue.
The mostly second-tier economic releases out of the US continued to paint a positive picture of the economy, and so far we see little impact from the January tax hikes or the March sequester budget cuts. The rebound in the housing market and the moderate strengthening in the labour market are so far compensating for the added fiscal drag. Both seem set to continue: weekly jobless claims is still trending lower, and housing starts and permits rose sharply last week. The small size of the US trade sector means that it can bear the European crisis better than any other major economy, and we expect the dollar to trend higher into 2013.