Is money staying in Cyprus due to capital controls? Will this trigger outflows of euro-zone banks in other countries? Can we expect more flows to the UK? Christopher Vecchio of DailyFX dives into these questions and also discusses a potential euro-exit of Cyprus. The impact on other countries depends on the success or failure of Cyprus after the exit.
This is the second part of the interview. Here is the first part focusing on the BOJ’s two step approach
Christopher Vecchio is a currency analyst for DailyFX. With a background in political science and law, he focuses on the interrelationships between geopolitical events, macroeconomic trends, and market reactions. Also an active trader, Christopher monitors the markets around the clock. Expertise: News events, market reactions, and macro trends.
Could the crisis in Cyprus trigger significant outflows out of banks in other troubled countries? Is there an easy way to track the numbers?
Not initially. The capital controls put in place by the Cypriot government will give the illusion that only a small portion of depositors withdrew their holdings from Cypriot banks. Only when the capital controls are removed we will find out the real extent of the panic among the Cypriots. If the Cypriots lash out against the measures, that’s when the unease will kick in. Depositors in countries like Italy or Spain could be anxious once the reality of the capital controls hits the economy.
Presently, it’s difficult to keep track of all the money flowing in and out of the country because of the grace period Cypriot President Nicos Anastasiades offered depositors after the parliament voted down his bailout proposal, spurring a week of tense negotiations across Europe, including Russia. The two largest banks involved in the crisis, Bank of Cyprus and Cyprus Popular Bank – more commonly known as Laiki – skirted the blackout on funds due to subsidiaries’ branches being open outside of the Euro-zone, mainly in Britain and the Euro-zone. Rumors have it that funds are fleeing to Latvia, but again, there’s no exact number just yet. We’ll have to take what we hear from the Cypriot government as the best estimate, when it’s released.
I think we have thus far: while the EURUSD has dropped to fresh yearly lows below 1.2800, the the GBPUSD has steadied near 1.5200, pushing the EURGBP back from two-year highs near 87.00 to near 84.00. The Bank of England’s loose monetary policy promises the liquidity haven investors seek, and is more or less a regional safe haven option, now that the Swiss Franc has been relegated to the sidelines. However, this iteration of the crisis, the US Dollar is in better economic position than the British Pound, whose economy just entered the third leg of a recession. Similarly, the Federal Reserve is hinting of a future with no QE, while the BoE is exploring ways to help stimulate the economy further. In summation, I suspect that EURGBP could drive lower, but the EURUSD should dive lower as well, by a greater force, putting downside pressure on the GBPUSD too.
The benefits of a Euro-exit would only be bestowed upon Cyprus: they could devalue their currency in order to drive tourism and exports, with a burgeoning natural gas energy sector replacing a lightly-regulated financial sector. Iceland has recovered from the financial crisis faster than any country in the advanced world – and it let its banking sector fail while devaluing its currency in the process. Cyprus could be competitive in the market within three to five years if it left the Euro-zone, devalued its currency, and rapidly expanding its energy sector.
The Euro-zone is a trickier call: at first, it would jar markets that a member country actually left, but I still think that there would be a relative period of calm. After all, Cyprus is just 0.2% of overall Euro-zone GDP, so an exit could be easily managed with little ripple effects, if handled carefully and under intense legal supervision. The big question would be: how was the exit handled? If Cyprus leaves and the economy spirals out of control, then it could be a Euro positive; pundits will quip ‘Cyprus should have stayed in the Euro-zone to access Germany’s help.’ But if Cyprus were to leave in an orderly fashion, and the economy recovered relatively quickly, then it is incredibly likely that more peripheral members would consider an exit, now that there is empirical evidence to point to.
You can follow Vecchio on Twitter: @CVecchioFX