ECB Re-Bluffs To Cyprus Bluff, Is "Prepared To Let Cyprus Go"

When the market briefly surged yesterday, following the cryptic note from the ECB that it would "provide liquidity within existing rules" we urged to ignore the kneejerk algorithmic exuberance (although with only algos left trading that was obviously self-defeating) which interpreted this as an indication the ECB would provide unconditional liquidity now and forever, and that this was hardly a bullish sign because "the last thing the ECB wants is to appear weak, and fold letting every other broke deadbeat country to demand the same equitable treatment and diluting Germany's political might." Today, Reuters has picked up on this coming out with its own analysis that the "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."

It is unclear how much of the article is actual analysis, and how much interest-driven propaganda to put the ball back in Cyprus court with the imputed knowledge that the ECB will not fold and thus cave to Troika deposit haircut demands, but fundamentally the logic is there as, once more, the ECB will hardly want to appear weak and cave in to a "recalcitrant" and unyielding Cyprus. Of course, what happens if indeed Cyprus decides to pull the € plug, should Russia provide an unlimited backstop and in the process subjugate a part of European territory without firing a shot, and the precedent that Europe can and will let members go, nobody knows but one thing is certain: stocks will go, as always, up.

From Reuters:

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.

"Tools" such as the unlimited, open-ended and very much non-existent OMT, which only "works" as long as it never has to work, because the Deus Ex qualities attributed to it by Draghi would actually have to be formalized, with the legal conditionality precedents put in writing should it truly start buying up bonds, something which would immediately destroy its image as the "end all, be all" bazooka that can fix any ailment. Which is why the second the OMT must be used, is when the entire European house of cards implodes. The catch is that a country must first agree to an aid plan of reforms and austerity measures. The Cyprus case has highlighted just how difficult agreeing such a program can be. "Even if the principle of OMT is still there and valid, all the drama about Cyprus may remind people that the bar to get OMT is actually higher than they probably think," Deutsche's Gilles Moec summarized.

As for the ECB's hard line:

By stressing that it stands ready to provide liquidity "within the existing rules", the ECB is standing firm.

 

The central bank is not ready to bend for Cyprus.

 

As its governing council gathered for a mid-month meeting on Wednesday, Asmussen pressed Cyprus to agree to an aid plan:

 

"We can provide emergency liquidity only to solvent banks and ... the solvency of Cypriot banks cannot be assumed if an aid program is not agreed on soon, which would allow for a quick recapitalization of the banking sector.

 

With Cyprus sovereign bonds ineligible for use as collateral for ECB refinancing operations due to their low credit ratings, the Cypriot central bank is providing banks with Emergency Liquidity Assistance (ELA).

 

These emergency loans are more easily available, but the ECB's Governing Council must approve provision of ELA. It reviews banks' eligibility every two weeks and needs a two thirds majority to stop these funds.

 

"If really need be, the euro zone would likely choose to let small Cyprus go and focus on containing the damage instead of softening the conditions to such an extent that much bigger countries than Cyprus could be encouraged to reject their own current bailout terms," said Berenberg Bank's Holger Schmieding.

And to think: so much pain and confusion over what CNBC can't stop repeating is nothing but a tiny, little country.

Tiny... maybe. But the precedent it will set may well be of Archduke Ferdinandian size.