In this week’s bulletin:
· Last-ditch deal secures bailout for Cyprus but its banking system pays the price
· Chancellor backs the “aspiration nation” to kick-start the economy
· Extension to the Bank of England’s powers underlines the need to boost growth and jobs
Back from the brink
- Last-ditch deal secures bailout for Cyprus but its banking system pays the price
For a country with a population smaller than Birmingham (850,000) and which accounts for barely 0.2% of the eurozone’s gross domestic product, Cyprus last week continued to play a disproportionately large role on the global economic stage.
After its banks lost €4.5 billion on Greek sovereign debt (as a consequence of the haircut previously imposed by the ‘Troika’ – the European Union, European Central Bank and International Monetary Fund) and failed to meet euro-area capital requirements, Cyprus was obliged to seek a €10 billion bailout from the European Stability Mechanism. The debate raging in the last week has been over how the country raises €5.8 billion to secure the loan. In Greece, the equivalent debt write-off came from the banks which had bought government debt; but with (wisely) few global banks holding Cypriot debt, the money has to come from the Cypriot banks’ customers. The Cypriot parliament rejected the first set of proposals, which would have seen 6.75% taken from small savers and 9.9% from larger investors.
At €126.4 billion, the assets held in the country’s banks are seven times the size of its economy. A little less than half of that money belongs to non-residents, of whom Russians are estimated to account for around 80%. It is not difficult to understand the attraction of Cyprus’ banking system or the unsustainability of the country’s economic model. In January, Cypriot banks paid an average of 4.45% on deposits of less than two years, compared with 4.25% in 2008. In the same period, the European Central Bank cut rates to 0.75% from 4% and German banks lowered theirs to 1.5% from 4.01% (source: Financialpost.com, 19 March 2013). For Cyprus in 2013, think Iceland in 2008 – but with added sunshine.
In playing hardball, the eurozone, led by Germany, sent Cyprus a very clear message; its economic model has to change and they will no longer accept the idea of a national economy within the eurozone that is dependent on its reputation as an offshore tax haven.
“The actions of the Troika appear to be very much with a future banking union in Europe in mind, although it may take several years to put together,” commented Stuart Mitchell of S. W. Mitchell Capital. If that is indeed the longer-term scenario, with the likes of France and Germany underwriting the scheme, then the message is that a clean-up of the old debts needs to come first, with the countries responsible taking the pain.
By the end of the week, and despite fears of contagion, markets had reacted to the drama more calmly than to previous stages of the eurozone crisis. The FTSEurofirst 300 Index ended the week down just 1%, although European banks were some of the biggest losers, and peripheral eurozone government bond yields remained firmly below last year’s levels. Volatility indices barely fluttered. Uncertainty over Cyprus and the broader outlook for the eurozone did, though, put an end to the run of five successive weekly advances for the FTSE 100 Index, which finished the week down 1.5%.
In contrast to the eurozone, where preliminary purchasing managers’ surveys for March indicated that the recession in the region has deepened, the recovery in the US appears to be strengthening, as the flash manufacturing PMI there rose to 54.9, a level consistent with rapid growth. However, in reaffirming its commitment to an $85 billion-a-month asset-purchase programme last week, the Federal Reserve made clear that it was not yet intending to start exiting its accommodative policy stance aimed at boosting economic growth and bringing down the unemployment rate. After a choppy week, during which the S&P 500 Index came within a whisker of reaching a record closing high, Wall Street ended the week down 0.3%.
In Japan, the Nikkei 225 Average suffered its biggest weekly loss since November, declining 1.8% as worries about Cyprus helped push the yen higher, which weighed on exporters’ shares.
As Cypriot President Nicos Anastasiades held a series of emergency meetings in Brussels over the weekend, the country appeared to face two choices: to continue to provide a convenient home for Russian oligarchs’ wealth; or to turn fully towards Europe, close much of its questionable banking sector and rebuild its economy on something more sustainable.
This morning, markets woke up to the news that a last-minute deal had been agreed by eurozone finance ministers, which brings Cyprus back from the brink of the collapse of its banking system and exit from the eurozone. The deal will see the country’s second-largest bank – Laiki (Popular) Bank – wound down, with bondholders and those with deposits of more than €100,000 (£85,000) facing significant losses. However, all deposits under €100,000 will be fully guaranteed.
The plan does not need approval from the Cypriot parliament because the losses on large depositors will be achieved through a restructuring of the island’s two largest banks and not a tax. Laiki will be split into “good” and “bad” banks, with its good assets eventually merged into Bank of Cyprus. The percentage to be levied on large deposits in the Bank of Cyprus will be resolved in the coming weeks. What is clear is that the island faces years of deep recession.
“It’s been a particularly difficult road to get here. We’ve put an end to the uncertainty that has affected Cyprus and the euro in recent days.”
Jeroen Dijsselbloem, Minister of Finance, The Netherlands
Given the events of the last few days, it is ‘interesting’ to revisit the words of Jean-Claude Trichet, ex-president of the European Central Bank, back in early 2008: “For a small, open economy like Cyprus, euro adoption provides protection from international financial turmoil.”
At the time of writing, markets had responded positively to news of the deal: Germany’s DAX Index was up 1.1%, Japan’s Nikkei 225 Average had risen 1.7%, recovering most of last week’s losses, and the FTSE 100 Index was up 0.5%.
Banana skins avoided this time
- Chancellor backs the “aspiration nation” to kick-start the economy
- Extension to the Bank of England’s powers underlines the need to boost growth and jobs
After the gloom of the Budget came some good news in the shape of February’s UK retail sales volumes. The impressive 2.1% monthly rise in sales volumes far exceeded the consensus forecast of a 0.4% gain. Although the rise was partly a bounce-back from the snow-driven dip in January, it more than reversed that month’s drop of 0.7%. Supported by retail surveys which also indicated a pick-up in momentum, the figures raised hopes that the economy will have avoided a triple-dip. However, whilst the Budget provided some further help for households (e.g. axing the planned rise in fuel duty), with real pay still dropping sharply, a sustained recovery in consumer spending still seems unlikely soon.
With the Chancellor’s statement last week being variously described in the press as “an exercise in rearranging the deck chairs” and “the worst Budget ever for savers”, as the newspaper column inches piled up, what became clear was that hopes are being pinned on house builders and homeowners to breathe some life into the economy, whilst savers and pensioners should brace themselves for years of record-low interest rates and the stealthy erosion of their spending power from higher inflation.
Commenting the day after the Budget, Richard Peirson of AXA Framlington offered his view. “The Chancellor had little scope to stimulate growth without scaring the currency and bond markets. We therefore had a lot of small measures announced which in total cost little and are unlikely to generate much additional growth in the short term. Unless we have missed something, however, there are no obvious banana skins like last year. The major beneficiary was the house-building sector and the shares of the listed companies, a number of which we own, responded strongly subsequently. I suspect that yesterday’s news will soon be forgotten as investors resume their focus on global issues.”
With a view to targeting unemployment and achieving the elusive growth, Mr Osborne announced new powers for the Bank of England (BoE) and its incoming governor, Mark Carney, allowing it in future to use “unconventional monetary instruments to support the economy”. This reflects Osborne’s desire for the Bank to give clearer long-term economic signals to businesses and homeowners about interest rates. However, just promising to keep interest rates low for a long time might not make much difference given that markets already expect rates to stay at 0.5% until the end of 2015.
The challenge facing the Chancellor was underlined by another sharp downgrade by the Office for Budget Responsibility (OBR) to its forecasts for both growth and borrowing. The OBR halved its growth outlook for this year to 0.6% and reduced its 2014 prediction from 2.1% to 1.8%. Also on Wednesday came news that inflation rose to a nine-month high, with the Consumer Price Index hitting 2.8% in February. In giving the BoE a more flexible remit, there are concerns that it may take its eye off the inflation ‘ball’, although both the Bank and the Treasury stressed that price stability remained paramount and that the 2% inflation target would be unchanged.
Clearly, the immediate outlook for savers remains bleak. According to the forecasting group ITEM Club, someone who deposited £10,000 in 2009 will now be sitting on a real-terms loss of £1,297. It may not be as draconian as the planned raid on Cypriots’ deposits, but the damage that inflation continues to do to the value of savings is equally permanent. Perhaps the only bright spot for savers in the Budget was news that consultation would begin on a process for allowing the transfer of Child Trust Funds into Junior ISAs, a move which would affect 6 million children and offer more flexibility for those locked up in accounts where fund choices are often limited and costs high. Although a welcome development, any change is unlikely to take place before the end of the year.
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