Why Cyprus still matters

Why Cyprus still matters

Good morning and welcome to today’s foreign exchange market commentary on Monday, the 14th of January.

The tail-risk of a eurozone breakup is unlikely, or at least that’s what European policy makers have tried to impress upon investors. Some have even gone further to indicate that the worst is behind us. They cite the narrowing of Italian and Spanish 10-year spread over similar maturity German bunds and Ireland’s slow return to the capital markets.

Challenges galore nonetheless. Spain has trimmed public investments over the past few years while government spending has actually gone up. Without another LTRO from the ECB, Spain’s ability to raise funds will be severely constrained. Greece’s ability and willingness to impose further austerity also remains questionable. Finally, the next Italian election in February can very well result in a hung parliament.

But Cyprus still tops the agenda. Though it’s a small economy and international investors have relatively smaller exposure to the country, it can still pose serious challenges. To begin with, no body quiet knows the amount of funding it will require to tide over the crisis. Hence, an aid package is unlikely to be announced when European finance ministers meet early next month. As no formal help will arrive before March at the earliest, Nicosia is likely to “manage” the funds by borrowing from state-owned institutions and government pensions.

The recent divergence within the troika doesn’t bode well for Cyprus either. The IMF’s proposal of involving the private sector for debt restructuring before tax payer’s money is given flies in the face of earlier assertion where European officials had said Greece was an isolated incident to get this benefit. Despite resisting involvement early on, European officials are now unwilling to proceed without IMF participation now.

A German news report of money laundering by Cypriot banks, especially for Russian oligarchs, has complicated matters further and Germany may very well face opposition from within. Any aid proposal could be vetoed by the Bundesbank citing broad concerns while opposition parties may raise this issue before the September general elections.

Finally, the Cypriot presidential elections scheduled for Feb 17 may come a cropper if no candidate receives 50% or more votes. Considering the result of recent polls, this seems to be the most likely outcome which will lead to a second round of elections on Feb 24. In short, chances of Nicosia exiting the currency bloc still remain high.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2056
GBP/US$ – 1.6126
GBP/CHF – 1.4741
GBP/CAN$ – 1.5876
GBP/AUS$ – 1.5282
GBP/ZAR – 14.0625
GBP/JPY – 144.24
GBP/HKD – 12.4968
GBP/NZD – 1.9201
GBP/SEK – 10.4230

EUR: The single currency continued to gain ground against the US dollar on Friday following Thursday’s ECB press conference where the central bank predicted that the eurozone will return to growth by the end of 2013. The EUR/USD pair got further boost after Italian and Spanish 10-year sovereign yields dropped further on Friday and the pair rose to a high of 1.3366. Investor sentiments are strong ahead of Federal Reserve chairman Ben Bernanke’s speech tonight and the EUR/USD pair touched a high of 1.3402 in overnight trade ahead of European industrial production data. Euro has advanced against most currencies and the pound is no exception. The GBP/EUR pair opens at 1.2077 this morning.

USD: The pound tracked the EUR/USD higher on early Friday but slipped after UK manufacturing and industrial production came in lower than expected. Manufacturing printed at 0.3 percent while industrial production dipped to -0.3 percent against expectations for 0.8 percent and 0.5 percent respectively. More bad news followed soon after when the National Institute of Economic and Social Research predicted that the UK economy contracted 0.3 percent in the fourth-quarter, raising fears that the UK economy is slipping into recession again. Sterling has gained traction against the greenback since then and has regained the 1.6100 level on improved risk sentiment in Asia. We have Ben Bernanke’s speech later in the day today and investors expect him to scotch rumours of the US central bank winding down its asset purchase program in 2013. The GBP/USD pair opens at 1.6120 this morning.

Have a great day!

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