Investors wary of "slow panic" on growth after Cyprus rescue

By Mike Dolan

LONDON (Reuters) - World markets have reacted calmly to the twists and turns of Cyprus's financial rescue in the last fortnight but many investors fear the economic fallout is yet to come.

They have sold European assets, rather than make a global dash for safety that could signal concerns about a euro breakup.

Euro blue chip and bank equity prices, regional bank bonds and the euro exchange rate have all fallen sharply this week but Wall St stocks set a record closing high.

Mutual fund data released by fund tracker EPFR on Friday showed that European equity, bond and money market funds all saw hefty redemptions this week even as investors continued to pile into Japanese and U.S. equity funds.

Cyprus's 10 billion euro rescue averted an immediate financial meltdown that could have caused a Lehman Brothers-style shock in financial markets.

But it came with a forced shut down of the island's second largest bank and a raid on bank deposits of over 100,000 euros, that forced big depositors to become part of the rescue.

Global investors are worried that the precedents set in the messy rescue will strain bank funding, hurting businesses and the fragile regional economy and delaying any recovery.

Ben Bennett, strategist at British fund managers Legal and General Asset Management described the scenario of depositor fear, bank solvency and recession as a "slow panic".

"I don't think there's anyone who's woken up in a cold sweat at midnight wondering what assets they need to dump - this is much more of a slow grind," said Ben Bennett, strategist at British fund managers Legal & General Asset Management.

Investors are worried that the precedents set for resolving a bank's problems has pushed up the cost of lenders' funding.

If banks have to pay more to borrow they will be reluctant to lend to businesses, already grappling with a recession and difficult credit conditions.

This would hurt growth and questions about the ability of the bloc to shake off its debt spiral and the viability of Europe's single currency would resurface.

Forcing savers to take a hits also sets a precedent that may mean depositors in other countries withdraw money more quickly in the future if they hear of troubles in the banking system.

DEPOSIT RADARS

While the principle of bail-ins for senior creditors may have been flagged for some time the impact of the depositor exposure is a wild card.

Investors are looking for any sign that savers elsewhere in Europe withdrew deposits from banks fearing they might end up losing money like the depositors in Cyprus.

But it will be at least another four weeks before Europe's central banks release data on depositor behavior post-Cyprus for March and a fuller picture will take another month.

Until there is clear evidence, investors will be nervous, being led by anecdotal evidence and market pricing.

Euro bank stocks have lost more than 10 percent since mid-March to their lowest since September and default insurance costs on senior European bank bonds have jumped about 50 basis points over the same period to six-month highs.

While these price moves are relatively contained, the impact on growth of the higher costs bank will pay to fund themselves appears to be a much bigger worry for many investors.

The world's biggest bond fund manager PIMCO said last week it was cutting exposure to the euro currency and its chief executive Mohamed El-Erian told German tabloid Bild on Thursday that after three years of euro crises, recession on the periphery was hurting the core and "the costs are rising."

John Stopford, co-head of fixed income and currency at Investec Asset Management, said the confidence bought by the European Central Bank's promise last summer to do what was necessary to save the euro hinged on growth returning and policy finding a coherent tack.

The events in Cyprus raised questions about both, he said.

"I'm increasingly pessimistic," said Stopford. "It does seem to me the goalposts are being moved quite a lot at the moment and there's a danger (investor) trust will go again if they're not careful."

"There's a slow credit crunch going on where banks are having to strengthen balance sheets and events in Cyprus can only exacerbate that."

FEWER LOANS HURT GROWTH

Any problems in the banks would make things worse for the small and medium size firms that are crucial to economic growth and are already struggling to find lenders.

"The lack of funding to SMEs is clearly at the heart of the ECB's thinking at the current juncture, as a blatant and persistent sign that policy transmission remains significantly impaired," a Deutsche Bank report said this month.

The existing credit drought and ongoing fiscal austerity on business confidence has already been clear in regional Purchasing Managers Surveys that disappointed expectations again through February and March.

And beyond the surveys, positive euro zone economic surprises have all but disappeared over the past month.

"At some point does the cumulative pressure just precipitate a decision by countries to get out of here?" asked Stopford at Investec. "If you could turn around the economic dynamics, a lot of the other problems would look less challenging."

(Editing by Anna Willard)

Source: http://news.yahoo.com/investors-wary-slow-panic-growth-cyprus-rescue-012924594--sector.html

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