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Fundamental Morning Wrap: EUR relief at Cypriot "agreement"

FXstreet.com (Barcelona) - There was only ever going to be one focus for this mornings institutional research: Cyprus. News of the adjusted bailout look to have been more telling of the political power struggles taking place within the Eurozone and the news of the bailout (or agreement, depending on who you follow) has had a limited relieving effect on financial markets so far. The underlying suspicion is that despite the immediate risk being averted, dangerous precedents have been put in place.

EUR

The weekend news was undoubtedly centered on the Cypriot bailout, with Gareth Berry and Geoffrey Yu of UBS noting that the Troika and the Cypriot Government agreeing on key elements and Eurozone FinMins subsequently approving it too. They add that likely Dutch and German Parliaments will have to vote on the measures, but crucially, the Cypriot Government will not as the levy concept has been abandoned completely. Overall, for the Euro, they feel that the bailout is a double edged sword with deposit outflows likely to ensue as soon as banks reopen, but the immediate risk has been averted. However, they feel that political tensions could ensue.

Westpac analysts note that there has been a relief rally for EUR/USD as the threat of Cypriot financial collapse and EUR exit has been avoided. However, they add that the “woefully handled bailout of a tiny EMU member is hardly cause for a sustained rally. The Eurozone economy remains in recession with recovery distant, while the political standoff in Italy (outstanding debt of EUR1.7 trillion) continues.” ING economists cover similar ground, and add that regardless of the bailout it looks very likely that the country’s economy will contract significantly both in 2013 and 2014. Additionally, they flag that Moody’s already stated that even with a deal, Cyprus remain at risk of default. However, they largely see this period as being a power struggle within the Eurozone, rather than financial. They write, “The Cyprus bailout has been an unprecedented power struggle in the euro crisis. While Cyprus tried to call the Eurozone’s bluff, the Eurozone, led by Germany, wanted to make an example that the rescuers do not like to be blackmailed.” They see that Germany gambled that a Cypriot “No” would be more harming for the island, than the Eurozone, but this approach holds much greater risks with larger nations.

Jim Reid of Deutsche Bank notes that according to the Eurogroup, there will be an appropriate downsizing of the financial sector, with the domestic banking sector reaching the EU average by 2018. Further to that, the Cypriot authorities have reaffirmed their commitment to step up efforts in the areas of fiscal consolidation, structural reforms and privatisation. Additionally, he writes, “Reforms include an increase of the withholding tax on capital income and of the corporate income tax rate. There will also be agreement between Cyprus and the Russian Federation on a financial contribution. The IMF estimates that Cyprus debt will be about 100% of GDP by 2020.” Danske Bank analysts comment that the events in Cyprus, further increase the risk of bank runs and capital flight in Greece and Spain in the future and in the event that new renegotiation´s are necessary in the two countries it could provide faster unrest since money can flee the country for fear of loss. Lee Hardman of BTMU notes that the latest IMM report confirmed that recent developments in Cyprus have resulted in a build up in speculative short euro positions which have reached their highest level since late last year.

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