Italy and Spain remain the two monstrous concerns in the European sovereign crisis. As horrendous as it may prove for Cypriots — and a number of rich Russians with bank accounts in the country — the bail-out in their country is less of a worry for the rest of Europe.
As EuroWeek reported last July, the European Financial Stability Facility (EFSF) may not be able to tap existing bonds once Cyprus — one of its guarantors — has had to step out of the guarantee scheme. But short of a calamitous series of bank runs, it is hard to see how else the Cypriot case affects the broader sovereign crisis picture.
Italy and Spain are simply too big. The idea that the EU will demand a punitive windfall tax on savers in such large and struggling economies is unthinkable. That the ECB would be slow to ride to the assistance of Italy and Spain, having pledged to do its duty last year through the Outright Monetary Transactions (OMT) scheme, is also unthinkable.
The fact it took politicians so many months to get round to discussing the Cyprus bail-out — that is to say, long after the present and immediate dangers of Italy and Spain subsided last year — tells you all you need to know about Cypriot contagion risk and the precedent this bail-out will set.
That is why government bond markets across Europe barely reacted on Monday. The fact is that the few billions of euros that need to be found to bail Cyprus out could be raised in a week by SSA borrowers without anyone batting an eyelid.
That will not be the case should Spain or Italy go to the wall. However much Cyprus becomes engulfed in the smoke and mirrors of bail-out funding, EU institutions must not be distracted from the bigger task of ensuring Spain and Italy keep their market access, stay solvent, and keep on the path of economic reform.