CYP strengthens after ERM2 entry

Interest-rate cut expectations

The Cyprus pound enjoyed a smooth ride in the first few days of its entry into the Exchange Rate Mechanism (ERM2), and in fact appreciated compared with its pre-entry rate.

At the fixing session on Tuesday May 10, the pound recorded a mid-rate of 0.5774 per euro, 0.8% stronger than the CYP 0.5820/EUR rate on April 29, the last trading day before the pound entered the Exchange Rate Mechanism.

The rate on Tuesday was 1.4% stronger than the Cyprus pound’s euro central rate in the Exchange Rate Mechanism (ERM2) of 0.585274 per euro.

Within ERM2 Cyprus has an official fluctuation band of 15% either side of the central rate.

It must remain within this band for at least two years without devaluation in order to meet the exchange-rate criterion for adoption of the euro.

Statements by Central bank officials suggest, however, that countries are normally expected to keep within the 2.25% bands of the original ERM1.

Leak had no impact

Unless the Central Bank spent a lot of money on foreign reserves (which are not published on a daily basis), the exchange-rate data suggest that there was no impact on the Cyprus pound of the Financial Mirror report on April 27 suggesting that the pound could enter ERM2 that coming weekend.

From a rate of CYP 0.5821/EUR on Tuesday April 26, the pound appreciated to 0.5820 on Wednesday April 27 and to 0.5818 on the Thursday and Friday.

Only when it entered ERM2 did the pound slip 5 pips to 0.5823, but has been on an appreciating trend since then.

Interest rates cut on May 20?

The pound’s performance has raised hopes that interest rates will be cut when the Monetary Policy Committee meets on May 20.

Cyprus official rates are currently 225 basis points above the equivalent in the eurozone, and convergence to euro-area rates is expected over the two-year waiting period.

Comments by the Finance Minister, Makis Keravnos, certainly suggest that this is what he is hoping, but an uptick in inflation to over 3% in April may make the Central Bank deciders more cautious.

Fiona Mullen