* Cyprus bailout makes euro vulnerable to new selloff
* For now, euro recovers as focus switches to Japan
* Some analysts warn euro could drop to $1.20 in a year
By Jessica Mortimer
LONDON, April 12 Cyprus's messy bailout has left
the euro vulnerable to any new flare-up in the debt crisis, with
aggressive monetary easing in Japan masking problems that would
otherwise push the currency sharply lower.
Some analysts see the euro dropping to $1.20 or lower in a
year's time and warn market participants, soothed by last year's
European Central Bank pledge to preserve the euro and subsequent
bond-buying plan, may not be fully pricing in the risks.
The euro bounced back to $1.31, from a 4 1/2-month
low of $1.2740 hit last week in the wake of the Cyprus deal,
helped by big gains against the yen after the Bank of Japan
unveiled a $1.4 trillion stimulus plan on April 4.
Cyprus was the first euro zone bailout to hurt uninsured
depositors, leaving questions over whether bank deposits are
safe in indebted countries, such as Spain and Italy.
A new flare-up in the crisis could see depositors, fearing
the Cyprus deal will become a template for the future, move
money swiftly out of weaker peripheral banks.
"This would then create capital flight like we observed in
2011 and early 2012 (in Italy and later in Spain, where a bank
rescue deal was agreed in mid-2012). This is new after Cyprus,"
said Ulrich Leuchtmann, head of FX research at Commerzbank.
"The OMT (ECB bond-buying programme) is very good at
preventing sovereign bond spreads from exploding but it is not
geared to a privately-induced capital flight out of bank
accounts and bonds."
Commerzbank has warned clients the increased risk of another
crisis is not priced into the euro/dollar exchange rate.
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A Reuters poll published on April 3 showed analysts cut
their euro forecasts after the Cyprus bailout to a median $1.25
in 12 months. Ten of the 64 polled saw it falling to $1.20 or
But trends in options show that since the BOJ announced its
bond-buying plan investors have scaled back bets on the euro
falling, which built up after the Cyprus rescue was agreed in
The BOJ's monetary easing steps have made the yen a more
obvious sell than the euro, with traders speculating the euro
will benefit from Japanese investors seeking higher yields.
Unlike central banks in Japan, the United States and the UK,
the ECB is not printing money. Rather, its balance sheet is
contracting, adding to the euro's appeal to some longer-term
investors, such as central bank reserve managers.
"Currency wars elsewhere are masking inherent weakness in
the euro system which is creating a false sense of security,"
said Nick Bullman, chairman of consultants CheckRisk, which
advises on risk management on over $65 billion of assets.
Many analysts said the euro would do well in the short term
after the BOJ action but that this may not last.
Steve Barrow, Standard Bank's head of G10 currency research
argues the euro is being undermined in the longer term because
various investors, now including depositors, are hit when a
bailout occurs. He saw the euro at $1.20 by year-end.
Others, however, are reluctant to bet strongly against the
euro as the ECB's OMT programme makes it less likely that a
crisis will spread from one country to another.
Just under a quarter of those polled by Reuters forecast the
euro would rise to $1.30 or higher in 12 months time.
"$1.20 is not in my forecasts and it would have to gain a
lot of steam to get there. But you can't rule anything out,"
said Jane Foley, senior currency strategist at Rabobank.
She said it would "take a very significant collapse in
confidence" and investors were likely to wait and see how the
ECB and EU politicians handle the next banking crisis.
Some analysts said the ECB's anti-crisis mechanism could not
rule out a damaging flare-up in the debt crisis.
"The ECB's monetary framework has stopped the markets
betting on the worst-case scenario, but they cannot prevent such
a scenario from happening," said Lena Komileva, director of
research consultancy G+ Economics.
Signs of crisis could prompt companies and private investors
to shift deposits from the periphery into countries such as
Germany. Others might switch to the Swiss franc and
Danish crown, both of which are considered safe.
"Savvy investors, who tend to have the largest deposits,
have been given a huge heads-up to be aware and to move money at
the first sign of trouble," CheckRisk's Bullman said, adding the
euro could drop as low as $1.15 by year-end.
Analysts said euro/Swiss franc, which hit a six-week low of
1.21305 francs on Monday, and euro zone bank shares
could indicate bank stress and capital flight.
"The investor who buys euro/Swiss franc tends to be the more
pessimistic investor. It is a good indication of underlying
crisis fears," Commerzbank's Leuchtmann said.