Dreams Of Euro As Reserve Currency Further Hit By Cypriot Agony - Lombard Odier

Tom Burroughes

27 March 2013

European Union policymaker hopes that the euro would challenge the dollar as a global reserve currency have been further dented by the Cypriot debt crisis, also raising the costs of what happens if the eurozone breaks up, Lombard Odier Investment Managers said in a note yesterday.

“Developments in Cyprus have further dented the euro’s fledgling status as a reserve currency... It is now clear that in stress situations with mitigation of moral hazard an important driver, the current rules governing the single currency area may be changed to suit the creditors,” Salman Ahmed, strategist on the global and emerging fixed income team at Lombard Odier Investment Managers, said in a note.

Along with a host of wealth management firms, Lombard Odier weighed in on how to interpret measures to rescue the Cypriot economy and banking system. The bailout has broken from three years of eurozone crisis-fighting by penalising large bank depositors for the first time. Accounts with less than €100,000 ($128,500) have been spared a levy. The measures have rattled depositors such as wealthy Russians, who have been some of the heaviest users of Cypriot bank accounts in recent years since the end of the Cold War.

The spectre of possible capital controls in Cyprus – which flies in the face of the idea of the eurozone as a single monetary regime – has also rattled international market sentiment. The proposed levy on bank deposits, talk of capital controls and possible euro exodus continues to weigh on the euro versus currencies such as the Swiss franc and dollar.

The European Central Bank decided this week to give Cypriot banks access to emergency central bank funding. The central bank already offers banks unlimited liquidity with loans up to three months, and reserves the option to give them more funding certainty over a longer horizon by laying on another three-year funding operation, as it did a year ago.

Lombard Odier’s Ahmed pointed out that in the past, governments have created and interpreted rules to suit their needs. “According to the EU treaty, controls that inhibit the free flow of capital within EU borders are illegal and yet we are most likely to see draconian controls being implemented in Cyprus,” his note said.

“This means that Draghi’s now famous 'whatever it takes' pledge is situation-dependent. Such an all-encompassing promise did not apply when the European Central Bank threatened to pull emergency lending assistance to Cyprus,” he said.