Eurozone finance ministers demanded on Sunday that Cypriots pay up to 10% of their bank deposits in exchange for a €10bn (£8.5bn) bailout, prompting panic across the island as people rushed to cash machines to withdraw their savings.
That caused traders to dump shares across Europe, on fears it sets a dangerous precedent that could trigger bank runs in other eurozone countries.
Mohamed El-Erian, the chief executive of Pimco, the world’s largest bond investor, said: “In Europe, [the Cyprus bailout] could well undermine the recent tranquil behaviour of depositors and creditors in other vulnerable European economies – in particular Greece, Italy, Portugal and Spain.”
The euro slid to $1.2888 in early trade, its lowest point since December. One euro is now worth 86p. On the stock market, the FTSE 100 fell 100 points but by lunchtime had recovered to 6,448, a fall of 40 points or 0.65%.
France’s main share index, the CAC 40, dropped 1.4%; Spain’s IBEX was down 2%, while the Italian FTSE MIB sank 2%. Stock markets in Asia posted their sharpest declines for eight months.
Bank shares were particularly hard hit on fears that the panic would spread across the eurozone. In the UK, RBS and Barclays were down about 5%.
Gold, seen as a safe haven in troubled times, rose above $1,600 for the first time in more than two weeks.
Despite assurances from European officials that Cyprus is “exceptional” and the measures are “unique”, El-Erian said the Cyprus bailout has driven investors to demand higher returns to hold risky assets.
In the debt markets, the yield on Portugal’s 10-year government debt – effectively the interest rate – jumped 20 basis points to 6.194%. Yields on 10-year Spanish debt rose 11bps to 5.036%.
Some bankers now say the euro itself is now under threat. Lars Seier Christensen, chief executive of the Danish investment bank Saxo, said: “I believe it could be the beginning of the end for the eurozone as this is an unbelievable blow to the already challenged trust that might be left among investors.”
The Cypriot government was scrambling to ease the terms of the bailout on Monday to push the deal through parliament. The Wall Street Journal reported that it proposed spreading the pain of the one-off tax more evenly.
Under the new proposal, smaller depositors with up to €100,000 would be taxed at 3%; savers with €100,000 to €500,000 would be taxed at 10%; and those with more than €500,000 at 15%. The original deal was for Cyprus to tax every depositor with less than €100,000 at 6.75% and those over that amount at 9.9%.
But it is not clear whether the government will be able to win parliamentary approval for the deal, with some 24 of the parliament’s 56 MPs pledging to reject the plan.
The new Cypriot president, Nicolas Anastasiades, urged politicians to back the tax, saying it was essential to prevent the country falling into bankruptcy. He said: “I chose the least painful option, and I bear the political cost for this, in order to limit as much as possible the consequences for the economy and for our fellow Cypriots.”
But pressure was mounting on Anastasiades after Russian president, Vladimir Putin,blasted the levy as “unfair, unprofessional and dangerous”.