The Pound to Euro exchange rate (GBP/EUR) grew by around 0.6 cents to reach a 2-month high of 1.1852 yesterday as markets interpreted the announcement of strict capital control laws in Cyprus as negative for the single currency.
The Cypriot government announced a set of measures designed to prevent a mass exodus of money leaving the nation’s embattled banking sector. Although this scheme is unpopular, it is necessary to protect Cyprus’ banks from running dry. Economic confidence in the country has been stretched to breaking point over the past two weeks due to the controversial decision to raid deposits in order to secure an EU/IMF/ECB €10 billion bailout package.
The capital control laws include: a ban on withdrawals from savings accounts prior to the expiry date, a €300 per day limit on cashpoint withdrawals, and a suspension on the majority of payments outside of the country. Individuals will only be allowed to carry €3,000 in banknotes on each trip abroad. Import payments will only be permitted upon the receipt of the ‘relevant documents’. Credit/debit card transactions outside of Cyprus will be capped at €5,000 per person, per month. And those studying abroad will only be allowed to receive payments of up to €10,000 per quarter.
The Cypriot Central Bank purports that the drastic measures are only temporarily, initially only penciled in for 4 days. However, governments in other countries imposing capital controls usually find it very difficult to scale them back. Take Iceland for instance: 5 years ago “temporary” capital controls were imposed that are still in place today.
The decision to restrict the amount of money leaving the country heralds a new dawn for the Eurozone, and runs the risk of so-called ‘Cyprus Euros’ facing devaluation on the black market against regular Euros. Citizens may decide to accept lower rates of exchange on cash that is, oxymoronically, landlocked on the island of Cyprus in order to get their money out of the country; either in flights to safety, or for legitimate reasons such as vacations or purchases.
Frankfurt Lawyer Kai Schaffelhuber of Allen & Overy said before the details were announced:
“If you were to impose restrictions equally on capital transfers and payments, then economically a Cyprus Euro would be very different vis-à-vis a non-Cyprus Euro. You would have to buy non-Cyprus Euros to pay for goods and services in other countries. With rules of supply and demand, the Cyprus Euro could then take on a different exchange rate”.
Hopefully this scenario will not play out due to the fact that importers can use so-called Cyprus Euros as long as they have the necessary documents. However, if complications were to arise regarding documentation, or if laws were to be tightened in the future then the threat of a two-tier Euro currency could have profound implications for the social, political, and economical strength of the 17-nation bloc.
The Pound (GBP/EUR) received a slight boost against the Euro earlier this morning as the GfK UK Consumer Confidence index improved modestly from -27 to -26 in March. Whilst the Sterling to Euro exchange rate is trading close to a 2-month high, the single currency is also trading at a 4-month low of 1.2752 against the US Dollar.
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