Greece, Cyprus May Be Forced to Exit Euro: Citi
Major debt restructuring for both Cyprus and Greece will probably force the struggling euro zone countries to leave the single currency, according to Citigroup's latest economic outlook, which warned markets could again be hit by escalating fears.
Stocks on both sides of the Atlantic have remained relatively sanguine in March as the so-called Troika (the European Commission, the European Central Bank and the International Monetary Fund) agreed to give Cyprus a 10 billion euro ($13 billion) bailout. The country also imposed credit controls and a levy on large deposits.
But the story is far from over, according to Citi, with the euro area's economic prospects remaining far from healthy.
(Read More: Cyprus Bailout in Danger as Opposition Grows)
"We continue to assume that Greece and Cyprus will leave EMU (European Monetary Union) over time," Citi said in the note published late Wednesday.
"We expect the euro area to stay in recession for this year and 2014 - with deep recessions in most periphery countries - and with further episodic flare ups of financial market tensions."
Cyprus at some stage will probably undergo its first restructuring of sovereign debt, which could put its place in the monetary union in jeopardy, Citi added. This could be prompted by a collective recognition that severe economic weakness will throw the current reform program badly off track or by a political decision in Cyprus to abandon the Troika's plan.
Germany's parliament backed the bailout for Cyprus by a large majority on Thursday but concerns still remain with the Cypriot parliament set to vote on the final package. Cyprus' attorney general, Petros Clerides, released details of an unscheduled vote on Wednesday, according to Reuters, with early signs that nearly half the members of the 56-seat parliament may oppose the bailout.
(Read More: German Parliament Backs Cyprus Bailout)
The Cypriot Greens Party, with just one member in parliament, became the first to openly announce its intentions to reject the deal.
"There are numerous possible triggers that could cause market strains to escalate again. But even if financial tensions do not worsen further, we expect that the ECB (European Central Bank) will soon cut rates again, probably at the May meeting," Citi said.
The bank believes that various "credit easing measures" could come into play as central banks and regulators take a more lenient view on the indebted nations. Strict austerity measures in the euro zone have received growing attention this week with EU Economic and Monetary Affairs Commissioner Olli Rehn telling Reuters on Thursday that budgetary belt-tightening could be slowed to help reinvigorate economic growth.
(Read More: Troika 'Blackmailing' Greece: Opposition Party)
Spain and Italy won't escape unscathed, according to Citi, with a continuing vicious circle between poor bank credit availability, economic weakness and rising unemployment in most peripheral countries.
"Italy and Spain eventually will enter some form of ESM (European Stability Mechanism) program this year. Some restructuring of government debts and/or bank liabilities remains likely in a range of countries over time, including Portugal, Cyprus, Italy, Spain and Ireland," Citi said.
—By CNBC.com's Matt Clinch; Follow him on Twitter @mattclinch81