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Cyprus, ECB and BoJ Weigh On Markets

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As details of the Memorandum of Understanding (MoU) between government and the “Supreme Savings‘ international lenders” were revealed on Tuesday, markets stepped back to gauge the 10 billion euro bailout. Markets also slowed in anticipation of this week’s updates from the Bank of Japan (BoJ) and the European Central Bank (ECB). Investors are concerned about whether the BoJ will scale down its proposed easing initiative. At the same time, the ECB will need to calm investor fears in the wake of the Cyprus fiasco that cost international investors billions of euros.

One of the big concerns facing the euro zone and the European Union is whether the Cyprus model is the model that could befall Spain and Italy. A general lack of confidence in the EU has led to the paring of the euro. Investors are unclear as to the direction of the BoJ and the USD rose to its highest level in two weeks against the yen.

Cyprus Turnaround Outlined

The MoU leaves little doubt about what the bailout investors, who contributed 10 billion euros to the troubled banking sector, will require of Cyprus. Meanwhile, the former finance minister resigned in anticipation of legal action for his roll as President of the country’s second largest bank, which failed last week.

As if there was not enough disgruntlement on the island nation, Cypriots are now staring at some lofty goals that are likely to impose the similar austerity sanctions other southern tier euro zone neighbors face.

The MoU says Cyprus must attain a four percent of GDP primary surplus by fiscal year 2017. This would a significant turnaround.

Reuters reports there are a number of other goals established by the MoU:

  • In 2013, Cyprus will suffer a 395 million euro budget shortfall (2.4 percent of GDP) in 2013.
  • This shortfall exceeded the 1.9 percent deficit in 2012.
  • In 2014, the deficit will expand further to 678 million euros.
  • The MoU expects the deficit to pare down to 344 million (2.1 percent GDP) by 2015.
  • In 2016, Cyprus is charged to achieve a primary surplus of 204 million euros (1.2 percent GDP) by 2016.
  • By 2017, Cyprus must achieve a 4 percent surplus by 2017.
  • Growth in Cyprus will contract by 8 percent this year.
  • Growth in Cyprus will contract 3 percent in 2014.
  • Growth will finally increase by 1 percent in 2015 and 2016.

In light of these assumptions, Cyprus has much work to do to live up to expectations. The 8 percent paring of GDP suggests a good amount of austerity will be necessary and Cypriots have thus far rejected most EU initiatives.

The MoU states that Cyprus will earn about 1.4 billion euros by selling certain state-owned assets, such as state-owned telecoms. Additionally, Cyprus expects to realize revenue from selling off rights to undersea natural gas deposits, which have been found of the island coastline.

The future of the public sector will be under pressure with new actions taken by government. The banking sector employment is already in turmoil. Now, government has announced that public sector pensions are frozen. The retirement age will be raised by 2 years. New taxes will be imposed upon alcohol, tobacco products and petrol. The VAT will be increased and corporate taxes on earnings and on interests earnings will also rise. Fees for all government services will increase by 17 percent effective immediately.

These measures are designed to ensure that debt in Cyprus is at 100 percent by 2020.

The ECB, BoJ and BoE

Investors are anxiously awaiting results from the three central banks. There are concerns that the BoJ will scale back on its proposed quantitative easing policy.

The ECB is now expected to hold steady on current interest rates. Prior to the Cyprus crisis, it was projected that the EC would raise interest rates.

In England, the BoE is expected to continue its current purchase of asset program without increasing the stimulus. British sterling gave back recent gains in anticipation of the upcoming central bank meeting. It is nervous times on the currency front.

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