LONDON (AP) — A relief rally in stock markets in the wake of the Cypriot bailout deal proved short-lived Monday after a top European official warned that a similarly tough strategy should be used across the region.
In the immediate aftermath of the deal between the Mediterranean island nation and international creditors, stocks had rallied and the euro edged back up above the $1.30 mark. But as the day wore on, the optimism ran dry.
Markets began to fall sharply after Jeroen Dijsselbloem, the Dutchman who chairs the meetings of eurozone finance ministers, said Cyprus' bailout should become a template for dealing with troubled banks across Europe.
The eurozone countries and the International Monetary Fund granted Cyprus a 10 billion euro ($13 billion) bailout that foresees dissolving the country's second-largest bank, wiping out its bondholders and inflicting significant losses — possibly up to 40 percent — on all deposits larger than 100,000 euros.
Dijsselbloem said that banks' bondholders and depositors should be prepared to take losses if the banks they put their money in run into trouble.
"The Cypriot bailout has a powerful legacy which may alter the security with which depositors elsewhere in the eurozone view the safety of banks," said Jane Foley, an analyst at Rabobank International.
In Europe, markets lost all gains to close lower. Britain's FTSE 100 ended 0.2 percent lower at 6,378.38 while Germany's DAX fell 0.5 percent to 7,870.90. The CAC-40 in France shed 1.1 percent to 3,727.98.
Markets in financially weaker states, such as Italy and Spain, took the biggest hit, as their bank shares fell on fears that depositors and investors could be scared away.
Italy's FTSE-MIB closed 2.5 percent while Spain shed 2.3 percent. The euro, meanwhile, slid sharply from about $1.30 to below $1.29.
On Wall Street, the Dow Jones industrial average lost earlier gains, trading 0.3 percent lower at 14,471 while the broader S&P 500 index lost 0.2 percent to 1,554.11.
The focus will likely remain on developments surrounding Cyprus for a while yet. In particular, investors will be interested to see if the level of bank withdrawals from the country's banks when they reopen. That's scheduled for Tuesday.
A longer-lasting concern is how the Cyprus deal plays out in other countries, notably those at the forefront of Europe's debt crisis. Will depositors look to reduce their holdings in Spain, Italy and Greece?
"It will set an unsettling precedent for future bailouts and investors will once again be concerned over the security of their bank deposits," said Mike McCudden, head of derivatives at Interactive Investor.
In return for a 10 billion euros ($13 billion) bailout from its European partners and the International Monetary Fund, Cyprus agreed to drastically shrink its outsized banking sector, cut its budget, implement economic reforms and privatize state assets — a cocktail of measures that mean the country's near-term economic prospects are bleak indeed.
The deal will allow the European Central Bank to continue providing liquidity to the remnants of Cyprus' banking system, thereby eliminating any short-term fears of bankruptcy.
Cyprus's side of the bargain is earmarked to raise 5.8 billion euros. To do so, the country's second-largest bank, Laiki, will be restructured and bond holders and savers with more than 100,000 euros deposited will have to take significant losses. Depositors in the biggest bank, the Bank of Cyprus, with over 100,000 euros will also bear a cost but those with savings up to 100,000 euros will be guaranteed in accordance with the EU's deposit insurance guarantee.
Earlier, investors in Asia had the first chance to respond to the Cypriot developments and there too the response in financial markets was of relief. Japan's Nikkei 225 index surged 1.7 percent to 12,546.46 while South Korea's Kospi jumped 1.5 percent to 1,977.67. Hong Kong's Hang Seng rose 0.6 percent to 22,251.15.
However, mainland Chinese shares fell Monday, with the Shanghai Composite Index down 0.1 percent at 2326.72, while the smaller Shenzhen Composite Index fell the same rate to 959.93.
Oil prices were solid despite the retreat in stock markets, with the benchmark New York contract up 88 cents a barrel at $94.59 per barrel.
Pamela Sampson in Bangkok contributed to this report.