The euro bounced on Monday after Cyprus’s deal with its lenders removed the immediate threat of financial meltdown but gains ran out of steam as investors focused on the grim outlook for the euro zone economy.
Worries about a broad euro zone slowdown, political uncertainty in Italy, and prospects of the European Central Bank easing monetary policy in coming months to support growth were expected to weigh on the currency.
The euro was flat on the day at $1.2990, off a session high of $1.3050, and not far from a four-month low of $1.28435 set last Tuesday as investors took profits on its rise.
The euro was marginally higher at 123 yen, well below the Asian high of 123.85 yen.
The deal for Cyprus, which was endorsed by euro zone finance ministers, includes plans to shut down the island’s second largest bank in return for a 10 billion euro ($13 billion) bailout.
The plan involves winding down Popular Bank of Cyprus, also known as Laiki, and shifting deposits below 100,000 euros to the Bank of Cyprus to create a «good bank». Deposits above 100,000 euros in both banks, which are not guaranteed, will be used to resolve Laiki’s debts and recapitalize the Bank of Cyprus.
The agreement came hours before a deadline to avert a collapse of the banking system in Cyprus after the European Central Bank had threatened to cut off liquidity support on Monday. The deal did, however, remove immediate concerns that Cyprus might be forced to exit the euro zone.
While the bailout deal initially pushed the euro higher, analysts questioned whether it would instil confidence among international investors, who could see it as a template for future bailouts in bigger euro zone countries with struggling banking sectors.
“A deal to avoid default was expected. But this sets a dangerous precedent for the euro zone,» said Peter Kinsella, currency strategist at Commerzbank, who expects the euro to weaken against the dollar.
“It is very worrying that expropriation of private sector capital is taking place. It increases the risk of a bank run and when it next happens it is unlikely that ECB policies of (providing) back stop will work then.”
Many in markets were skeptical about the euro’s outlook especially when the economy is facing recession. By contrast, the United States is showing evidence of a sustained pick up, pushing interest rate differentials in favor of dollar assets.
“People are focusing on European growth and the structural problems that are going to impede European growth,» said Sim Moh Siong, FX strategist for Bank of Singapore.
“We’re starting to see a greater contrast between U.S. growth and European growth. That contrast, I think, will continue to weigh on the medium-term outlook for the euro,» he said, adding that the euro could face short-term resistance at around $1.3140.
The yen, which tends to rise in times of financial market stress, retreated broadly as the worries over Cyprus eased. The dollar strengthened 0.2 percent to 94.65 yen.
Market expectations that the Bank of Japan will unveil aggressive monetary stimulus at its next policy meeting on April 3-4, the first under new BOJ Governor Haruhiko Kuroda, are seen likely to support the dollar against the yen in the near term.
Analysts say, however, that with expectations for drastic BOJ monetary easing already high, the dollar could run into some selling if policymakers disappointed at next week’s meeting.
With the yen under such pressure, the dollar hit a 3-1/2 year high of 96.71 yen on March 12, marking a gain of roughly 22 percent for the greenback compared with mid-November.