FTSE and Euro tumbles on Radical Cyprus Bank Levy

European stock markets and the euro slumped sharply on Monday morning as investors reacted to a radical plan to impose a levy on bank deposits by Cypriots in return for a full scale bailout.

The FTSE 100 opened 1.4% lower alongside a 1.7% fall in the DAX and over 2% falls in the IBEX and Italian Mib Indices. The euro fell close to 2 cents against the dollar and 1 cent against the pound. However, markets started to recover somewhat from the earlier and more aggressive falls with the FTSE 100 trading with a reduced loss of 42pts by 9.50am.

The key issue with the Cyprus developments is not the fact they require a bailout, but more so the precedent a move to use deposits to bailout banks now sets. Under the current plans – which are being renegotiated already and likely to change – deposits over €100,000 will be taxed by 9.9% and deposits less than €100,000 taxed 6.75%. A variation of this could be to reduce the tax on deposits of less than €100k to 3% and increase the levy on deposits higher than €100k and €200k respectively.

Despite this negotiation, the damage made to sentiment is already entrenched. Bank transfers in Cyprus is frozen and the long bank holiday weekend may be extended for another day to give Parliament more time to ratify by the bank deposit levy. Cypriots are queuing at cash points around the country trying to withdraw what they can before the levy is imposed.

The issue here is not Cyprus. After all, Latvia, Lithuania and Bulgaria all have larger economies by GDP than Cyprus. The issue is what the Troika (EU, ECB and IMF) are now willing to accept, which is using bank deposits to help fund bailouts. The move sets a dangerous precedent. This is where the real concern lies. It now becomes even higher risk to leave funds in stressed sovereign states.

The message this move sends is clear, don’t leave your money in one of the stressed sovereigns or your bank deposits could now be used for bailouts.

The Troika’s arm has been strengthened by the apparent lessening of the euro area risks seen since the middle of 2012, where the euro has strengthened 10 cents against the US Dollar, having traded as high as $1.3711 from $1.2040 in just six months. They are now willing to use a much more dictatorial stance and given the size of Cyprus’ GDP, this is a relatively lower risk area to get the message across to other states thinking about a bailout. Lets not forget, Merkel faces re-election later this year too and so we must consider the fact that this plan is also being used as a communique to Spain, Italy as well as citizens of stronger EU states such as Germany.