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How will the recent Cyprus bailout impact on the wider Eurozone?

joshua-RaymondJoshua Raymond, Chief Market Strategist at City Index
Like many of its neighbours, Cyprus has had all manner of financial problems to contend with, but astronomical levels of debt in its bloated banking sector has forced the new government to go cap in hand to the European Union for a much-needed bailout. After much negotiation and controversy, a €10bn deal was agreed, but what does it mean for the island nation and the rest of the continent?

Savings raid
In the early stages of the negotiations between Cyprus and Germany, the Eurozone’s largest economy, there was a very real possibility that part of the rescue package would come from savings of Cypriots with bank deposits in excess of €100,000. A levy would be imposed on all those with six-figure sums in their savings accounts starting at 6.75%, rising for those with more money.

Understandably, many ordinary Cypriots and expats from countries like the United Kingdom living in the country to enjoy retirement were up in arms, but the deal was agreed. However, as soon as news broke, thousands queued outside cash machines to take as much money as they could, which forced the Cypriot government to close the banks down temporarily.

Panic spreading?
Cyprus is the fifth Eurozone member to agree a bailout with the EU, following in the footsteps of beleaguered neighbour Greece, Spain, Portugal and the Republic of Ireland. Sharing close economic ties with Greece has exposed the Cypriot economy to serious damage, but with a deal now agreed, the storm appears to have been weathered slightly.
The reaction to the bailout from the markets point towards a short-term recovery, but it’s likely that the long-term for the Euro and the Eurozone could be a little bleaker. Cyprus has to repay some of the banking sector’s debts, while some of the stronger economies on the continent are grappling with bad news of their own.
Challenging times

Joshua Raymond from Cityindex.co.uk talked about the challenges ahead:
The farcical nature of the Cypriot bailout affected short term confidence in the single currency, which the European Central Bank has worked so hard to re-establish in the past few months and long term confidence in the banking sector within troubled eurozone states.

The whole deposit debacle was less about Cyprus – which has a smaller economy by GDP than Latvia, Lithuania and Bulgaria – and more about the conditions future bailouts may now dictate.These concerns were quickly cooled with several finance ministers trying to isolate this condition to Cyprus and not prospective bailout requests outside of the island but the damage to confidence has already been done.

“There was further bad news this morning following a surprise announcement that German unemployment rose unexpectedly in March, further fuelling concerns around the ability of the strongest economy in the region to help energise the Eurozone’srecovery..

A retest of the $1.27 level for the euro against the US Dollar now looks likely and a break below could herald even greater weakness for the euro.”, he concluded.

The German view
Germany is likely to foot most of the bill for the Cyprus bailout as it did for Spain, Portugal and Greece in order to prop up the single currency. Not long after the bailout was agreed, the Euro had recovered in the currency markets, which will have come as a relief to German economic bigwigs, but weak growth in the country could be a by-product of problems elsewhere.

There is growing resentment from many in Germany over the money given to help out other Eurozone member states which might come at its expense. Trying to rescue the Euro is in Germany’s interest, as failure could cost them even more, but the banking sector is expected to suffer far more damage.

Banking woes
It’s expected that funding banks will become even more difficult, while the retail banking sector is likely to incur yet more damage. As many ordinary people will worry about their ability to pay the bills, let alone save money, less people will feel inclined to open accounts, especially after the goings on in Cyprus.

Trust in the banking sector from consumers, which was already at a low level, is likely to fall further. If nothing else constructive is done to reverse that trend by Eurozone governments, then the likelihood is that many like Laiki Bank could go to the wall, leaving account holders and moneymen in a never-ending cycle of economic despair.

Settling down
Not long after the bailout, banks in Cyprus have reopened their doors during limited hours after being closed for just over a week. Meanwhile, limits on the amount people can withdraw have also been placed, which suggests that the government are doing all they can in order to keep their side of the bargain.

While little normality has returned to Cyprus, the Euro’s slight recovery last week has lightened the mood, although it reached a four-month low yesterday because of concerns over the deal. In the meantime, the whole world watches to see if Cyprus and other Eurozone countries can mount a sustained recovery.