March 25, 2013 / 2:11 PM / in 4 years

FOREX-Euro drops vs US dollar as Cyprus deal enthusiasm fades

5 Min Read

* Cyprus clinches last-ditch deal with international lenders

* Euro erases gains made on Cyprus deal,

* Sellers to emerge on any euro rallies as economic concerns weigh

* Yen drops vs US dollar ahead of BoJ meeting next week

By Julie Haviv

NEW YORK, March 25 (Reuters) - The euro slumped against U.S. dollar on Monday as initial enthusiasm stemming from Cyprus' last-ditch deal with its international lenders swiftly segued into fears about future implications of the bailout.

The euro initially rose above the $1.30 level after Cyprus struck a deal with lenders to shut down its second-largest bank and inflict heavy losses on uninsured depositors, including wealthy Russians, in return for a 10 billion euro ($13 billion) bailout.

Without a deal, Cyprus's banking system would have collapsed and the country could have become the first to exit the euro zone.

Although the Cyprus bailout relieved some of the anxiety in markets and initially pushed the euro higher, analysts said the deal could serve as a template for future bailouts in bigger euro zone countries with struggling banking sectors.

"The critical issue remains that of precedent for larger euro zone countries, and the way in which the Cyprus situation has been managed does not seem to inspire a great deal of confidence," said Ilya Spivak, currency strategist at DailyFX, in New York.

The euro was down 0.4 percent at $1.2932, off a session high of $1.3048 and not far from a four-month low of $1.2843 set last Tuesday as investors took profits on its rise. Reported large option expiries at $1.30 were likely to keep the currency close to current levels, analysts said.

"At best, depositors in Cypriot banking institutions now have to contend with capital controls locking up their money. At worst, they may lose as much as 40 percent of their holdings," Spivak said.

"This raises an important question: Why should a depositor in any Eurozone country similarly vulnerable to a banking crisis expect to be unscathed if a Cyprus-like calamity were to befall them."

The euro was last at 122.48 yen, down 0.2 percent and well below the Asian session high of 123.85 yen.

Worries about an economic slowdown in the euro zone, political uncertainty in Italy, and prospects of the European Central Bank easing monetary policy in coming months to support growth were also expected to weigh on the euro.

Cyprus' deal 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 pay off Laiki's debts and recapitalise the Bank of Cyprus.

"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 a) back stop will work then," said Peter Kinsella, currency strategist at Commerzbank.

Euro to Struggle

Despite the bailout removing immediate concerns Cyprus might be forced to exit the euro zone, worries about the euro zone economy and the uncertainty over forming an Italian government could hamper any substantial gains in the euro.

By contrast, evidence of sustained economic growth in the U.S. was pushing interest rate differentials in favour of U.S. dollar assets.

Data showed speculators increased their bets against the euro while bets in favour of the dollar rose in the latest week to their largest since the week of July 17.

The U.S. dollar was up 0.2 percent at 94.64 yen. The Japanese currency, which tends to gain in times of financial stress. retreated broadly as worries over Cyprus eased.

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.

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