Cypriot contagion risk rattles investors Tiny Cyprus couldn't really blow the global financial market recovery off course, could it? The rescue plan by European leaders for the highly-indebted Mediterranean country - which may hit ordinary depositors in its overgrown bank system - on Monday stalled a global equity rally that had gained pace in recent weeks. Yields on German Bunds, which move inversely to prices, fell to year-lows as investors reached for havens amid fears that the eurozone crisis was re-erupting. The threat was not about Cyprus, which normally scarcely registers on most investors" horizons. Instead, markets took fright at eurozone politicians" apparent continuing propensity for turning a small crisis into a bigger one, with contagion effects spreading across southern Europe. The past two years have also started with global investor sentiment improving - only for problems to re-materialise. This could be a flash in the pan, but it is a reminder to investors that the situation [in Europe] is not resolved. It could be the start of a Spring correction - just as we saw in 2011 and 2012," says Andrew Milligan, head of global strategy at Standard Life Investments. Confidence that the eurozone crisis was under control had been rising since Mario Draghi, European Central Bank president, pledged last July to do "whatever it takes" to preserve the region's integrity. His comments reversed deposit outflows from banks across the eurozone's southern "periphery," especially Greece. Together with moves towards stronger fiscal and banking union, which might eventually include a common bank deposit insurance scheme, markets became convinced that structural flaws in Europe's 14-year old monetary union were being rectified. Investors are now concerned that the unprecedented hit taken by depositors in Cyprus's banks will cause others elsewhere to take fright, undermine already-frail banking systems across the periphery, increase the potential liabilities facing cash-strapped governments and wipe out confidence in eurozone crisis management. "With each successive "one-off measure," it becomes harder to convince creditors not to panic the next time round - in particular when you so obviously make up the rules as you go along," says Matt King, credit strategist at Citigroup. Paul Griffiths, head of fixed income at Aberdeen Asset Management, says the broader concern for bank depositors is that "the EU can't be trusted." The market view on Monday was that such dangers were not imminent. Early losses were reversed and the reaction in early US trading was muted, although measures of market volatility picked up. The S&P 500 index had been rising steadily towards a fresh record high as investors have become less worried about the US's fiscal woes, as well as the eurozone crisis, and more confident about a global economic rebound. But the showdown over Cyprus follows the jolt to markets delivered last month by Italy's inconclusive elections, which left the eurozone's third largest - and second most indebted - economy without a stable government. The foundations for the market rally "have been badly chipped away by recent developments in Italy and Cyprus," warns Mr Milligan. Some hydraulic supports may need to be put into place - and quickly. Still, Cyprus need not cause a market collapse. The country was a special case within the eurozone, not just as a result of its size. Its heavy reliance on Russian bank deposits attracted the ire of German politicians especially. Because of the size of the banking system and the non-resident nature of bank deposits, our sense is that Cyprus will be an isolated case. The market reaction is indicative of that - it's not out of the ordinary," says Nick Gartside, chief investment officer for international fixed income at JPMorgan Asset Management. But it probably does break a taboo in terms of the impact on depositors. Markets have also shown greater resilience in recent months, as illustrated by the muted reaction to Italy's political crisis. The jump in peripheral eurozone government debt yields on Monday was even more modest, reflecting the fact that eurozone leaders had honoured their promise that last year's rescheduling of Greece's public debt would not be repeated. The ECB remains as a backstop. Activation of its "outright monetary transactions" programme, by which it would buy the debt of distressed eurozone countries, depends on governments accepting an approved reform programme. Italy's political stalemate has raised fears the OMT programme would prove ineffective: there is no government in Rome capable of agreeing on reforms. Cyprus's example will raise fears that in future rescues depositors will be hit. "The medium term risk is that if Spain and Italy were having problems and needed assistance, you would get people saying, "can they take our money?"" says Gary Jenkins of Swordfish Research. The gamble by eurozone leaders is that the region's recovery story will nevertheless remain intact, even after Italy and Cyprus. "It is not as neat and as pure as it was three or four months ago but none of these elements are enough to derail the story," says Gilles Moec, European economist at Deutsche Bank. Cyprus "adds to the amount of uncertain stuff that we have to keep at the back of our minds and which could come back to haunt us," says Mr Moec. They [eurozone politicians] really should not do this too often.