Analysis: ECB prepared to let Cyprus go, protect others

Wed Mar 20, 2013 12:36pm EDT
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By Paul Carrel

FRANKFURT (Reuters) - The European Central Bank is prepared to cut off funding to Cyprus and let the Mediterranean island succumb to financial meltdown if it has to, confident it has unlimited firepower to protect the rest of the euro zone.

Cyprus propelled the 17-nation bloc into uncharted waters on Tuesday by rejecting a proposed levy on bank deposits as a condition of a 10 billion euro ($12.9 billion) EU bailout.

Without the aid, much of it to recapitalize Cypriot banks, the ECB says they will be insolvent, and it requires banks to be solvent for them to receive central bank support.

Denied these funds, Cyprus would be left staring into a financial abyss.

For the rest of the euro zone, the ECB has a suite of policy tools at its disposal to prevent contagion - with bond purchases and unlimited liquidity offers to the fore.

ECB chief Mario Draghi has his ability to create new policy tools constrained by resistance in Germany, where business newspaper Handelsblatt last week ran a front-page picture of him under the headline: "The poisoned gift: how ECB President Mario Draghi is saving the euro and ruining savers".

Bundesbank chief Jens Weidmann opposed Draghi's bond-buy plan - he sees it as simply financing governments - but he is open in principle to funding measures like the so-called LTRO the ECB used a year ago to funnel banks 1 trillion euros of cheap money.

Given that, the ECB probably has no need to dream up new crisis measures and before it even deploys its existing ones, it will try to work with governments to reassure bank depositors.   Continued...

A structure showing the Euro currency sign is seen in front of the European Central Bank (ECB) headquarters in Frankfurt July 11, 2012. REUTERS/Alex Domanski