Cyprus as a Pandora’s Box

The attempt to levy a deposit tax on Cypriot accounts has the potential to further destabilize the European Union, with contagion risk elevating for other peripheral member states.

European policymakers have opened a Pandora’s box by attempting to levy a deposit tax in Cyprus. The proposed action amounts to a haircut, or worse, a wealth confiscation by the European Union (EU). The range and magnitude of the deposit tax make this action unprecedented in this crisis, and perhaps the history of major developed economies. One potential consequence is the spread of the perception that no deposits in the European periphery are safe, even if insured.

Contagion risk of bank runs and capital flight in larger economies like Spain and Italy has been significantly elevated, and this is likely to affect global markets in a dramatic way for an extended period. Worst case scenario is that the recent developments in Cyprus may prove to be Europe’s Lehman moment. Even if they do not, though, the EU has crossed a line that should never have been crossed.

Economic Data Releases

Rising Gas Prices Affect Retail Sales and CPI

Retail sales were stronger than expected, rising 1.1% in February, with half of the gains coming from gasoline sales.

  • Initial jobless claims continued to fall, with the reading of 332,000 putting the four-week moving average at a five-year low.
  • Industrial production increased by 0.7% in February, the best gain since November.
  • Business inventories rose 1.0% in January, the most since May 2011.
  • University of Michigan consumer confidence unexpectedly dropped to 71.8 in March from 77.6 a month earlier, falling to the lowest level since December 2011.
  • The NAHB homebuilder sentiment index fell to 44 in the March survey, the lowest in five months.
  • Housing starts increased to an annual pace of 917,000 in February, up 0.8%, slightly better-than-expected.
  • Building permits rose to the fastest pace since June 2008, jumping 4.6% from January to February.
  • The CPI rose to a 2.0% rate in February, with 75% of the increase due to gasoline prices.

International Releases Show Mixed Data

Eurozone industrial production returned to contraction in January, falling 0.4%.

  • Employment across the eurozone shrunk by 0.3% in the fourth quarter of 2012, the sixth consecutive quarter of falling employment.
  • The ZEW survey of German economic expectations rose to a three-year high in the March survey, although most responses were received before news of the proposed Cyprus bailout.
  • Industrial production in Italy rose for the first time since August 2012, gaining 0.8% in January.
  • The U.K. consumer price index for February reached its highest rate in nine months, 2.8%.
  • Industrial production in Japan was revised down to 0.3% from 1.0%, in the January reading.

Chart of the Week

Potential Contagion in Eurozone

Capital flow activity will determine whether the crisis in Cyprus will spill into other peripheral countries. Since Mario Draghi promised to defend the euro in July last year, deposit flows in Greece, Ireland, Portugal, and Spain have stabilized. A failure to reach an agreement on the resolution of the Cyprus crisis by policymakers could trigger a renewed deposit outflow in peripheral nations, which could have severe consequences for the eurozone as a whole. Close monitoring of bank deposit flows in the eurozone, therefore, is warranted in the coming weeks and months.


Source: ECB, Guggenheim Investments. Data as of 12/31/2012. *Note: Data excludes deposits from monetary financial institutions and general government. Data rebased to 100 at the start of 2009.

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