Euro Falls After Brief Relief Over Cyprus Deal

Getty Images

The euro fell against U.S. dollar and Japanese yen Monday as brief enthusiasm brought on by Cyprus' last-ditch deal with its international lenders swiftly segued into broader fears about the region's banking sector.

Euro losses sharply accelerated after Dutch finance minister Jeroen Dijsselbloem, who heads the Eurogroup, told Reuters and the Financial Times that the rescue program agreed for Cyprus represents a new template for resolving euro zone banking problems, and other countries may have to restructure their banking sectors.

(Read More: Cyprus Clinches Last-Minute Deal to Secure Bailout)

"The Cyprus deal removed some of the tail risk regarding a messy default and exit from the euro zone, but a dangerous precedent of seizing bank deposits was set, and Dijsselbloem's comments solidified concerns about future bailouts," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington, D.C.

"A depositor in an Italian or Spanish bank right now is likely to be reconsidering their capital allocations as well as those with counter-party risk in shaky euro zone countries," he said.

The euro was last down 1.1 percent at $1.2847, far below a session high of $1.3048 set after the Cyprus deal was struck and not far from a four-month low of $1.2843 set last Tuesday.

"In the coming weeks the key thing to watch will be capital outflows out of Italy and Spain," Esiner said. "That should severely complicate efforts by lawmakers and the European Central Bank to get financial markets calm."

(Read More: Cyprus Relief: Why the Rally May Be Short Lived)

The euro has initially risen above the $1.30 level after Cyprus struck a deal with lenders to shut down its second-largest bank and inflict heavy losses on uninsured depositors, including wealthy Russians, in return for a 10 billion euro ($13 billion) bailout.

Without a deal, Cyprus' banking system would have collapsed and the country could have become the first to exit the euro zone.

Although the Cyprus bailout relieved some of the anxiety in markets and initially pushed the euro higher, analysts said the deal could serve as a template for future bailouts in bigger euro zone countries with struggling banking sectors.

"The critical issue remains that of precedent for larger euro zone countries, and the way in which the Cyprus situation has been managed does not seem to inspire a great deal of confidence," said Ilya Spivak, currency strategist at DailyFX in New York.

"At best, depositors in Cypriot banking institutions now have to contend with capital controls locking up their money. At worst, they may lose as much as 40 percent of their holdings," Spivak said.

The euro was last at 120.89 yen, down 1.5 percent and well below the Asian session high of 123.85 yen.

"This raises an important question: Why should a depositor in any euro zone country similarly vulnerable to a banking crisis expect to be unscathed if a Cyprus-like calamity were to befall them," he asked.

Euro Under Pressure

Worries about an economic slowdown in the euro zone, political uncertainty in Italy, and prospects of the ECB easing monetary policy in coming months to support growth were also expected to weigh on the euro.

Uncertainty over forming an Italian government could hamper any substantial gains in the euro.

(Read More: Berlusconi Offer Fails to End Italy's Political Stalemate)

By contrast, evidence of sustained economic growth in the United States was pushing interest rate differentials in favor of U.S. dollar assets.

Data showed speculators increased their bets against the euro while bets in favor of the dollar rose in the latest week to their largest since the week of July 17.

The U.S. dollar was last up 0.4 percent at 94.08 yen, according to Reuters data. The Japanese currency, which tends to gain in times of financial stress, retreated broadly as worries over Cyprus eased.

Market expectations that the Bank of Japan will unveil aggressive monetary stimulus at its next policy meeting on April 3-4, the first under new BOJ Governor Haruhiko Kuroda, are seen likely to support the dollar against the yen in the near term.