ROB Insight is a premium commentary product offering rapid analysis of business and economic news, corporate strategy and policy, published throughout the business day. Visit the ROB Insight homepage for analysis available only to subscribers.
Events in Cyprus imply that the European Central Bank (ECB) is far more limited in its power to support the region's economy than investors currently believe, according to a prominent economist.
Megan Greene, formerly of Roubini Global Economics LLC and now Chief Economist for London-based consulting agency Maverick Intelligence, has a regular Bloomberg column and an active Twitter account. There are few better, more reliable public sources of European economic analysis.
In her most recent report, Ms Greene writes:
"Markets have weathered potential crises in Italy and Spain with surprising calm, secure in the knowledge that the ECB will save the day if needed.
This was always a false assumption, as events in Cyprus have made clear. There are significant limitations to the support the ECB is willing or able to offer, even to such a tiny island economy whose needs are easily affordable."
The ECB is likely to be sorely tested in Italy, where the country's major banks are struggling with an increasing number of non-performing loans. Italian banks have already been the beneficiary of ECB Emergency Liquidity Assistance (ELA) but Ms. Greene notes that the Cyprus semi-bailout underscored a new reluctance to use this facility. The only other available option in the ECB toolbox would be sovereign debt purchases, but this would be of marginal help to the country's major banks. In Cyprus, the ECB could have bought every outstanding bond issue and the proceeds may still not have been enought to bail out the country's banks. There is also the sticky matter of Bundesbank approval necessary for sovereign debt purchases to commence.
Market activity over the past week suggests that both debt and equity investors are recognizing the heightened levels of risk in the wake of Cyprus. Italian banks Unicredit SpA and Intesa Sanpaolo SpA have seen their stocks fall 12 per cent and 6.2 per cent respectively, from already depressed levels.
Perhaps more importantly, the costs of credit default swaps (CDS) on each bank's debt issues (the cost of insuring the bank's corporate bonds against default) have soared. CDS for Unicredit debt has jumped 20 per cent to 400 basis points, and the cost of insuring Intesa Sanpaolo's debt has climbed 22 per cent.
If Ms. Greene is correct that global investors have shown too much faith in the ECB's capacity to save the day for European banks, investors should prepare for volatility as markets reassess the ability – or lack thereof – of each European bank to stand on its own.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights, and follow Scott on Twitter at @SBarlow_ROB.
Scott Barlow