Borrowing costs for Spain and Italy tumbled on Monday as the European Central Bank intervened to buy the countries’ respective bonds and try to stabilise financial markets.
Dealers reported that the ECB had started buying the debt as soon as European bond markets opened. A senior Italian official said his impression was that the ECB was buying.
Yields on 10-year Italian bonds, which move inversely to prices, fell 65 basis points to 5.44 per cent, taking them well below the 6 per cent level above which they had been trading for much of last week.
Spanish borrowing costs also dropped, the 10-year bond yield falling 72 basis points to 5.32 per cent. The euro rose against the dollar.
At the same time, Spanish and Italian stock markets rebounded sharply, Spain’s Ibex 35 index rising 3.3 per cent and Italy’s FTSE MIB up 4.1 per cent.
Shares in battered eurozone banks were also rising sharply, with Italy’s Unicredit and Mediobanca up 6.5 per cent and 5.6 per cent respectively. Other banks, including Spain’s Santander and UK-based Royal Bank of Scotland, which tumbled heavily at the end of last week, were rallying strongly.
The rebound in European bank stocks and peripheral debt - the wider Eurofirst 300 index of leading stocks was moving into and out of positive territory - eased fears over the weekend that Monday would see a precipitous slide in the value of Spanish and Italian debt.
The G7 group of industrialised nations said on Monday morning that it was ready to intervene in foreign exchange markets if conditions warranted, and that the “market’s trust” in US Treasuries had not changed.
“These actions, together with continuing fiscal discipline efforts, will enable long-term fiscal sustainability,” the
statement said.
Investors initially sought out safety in the face of widespread selling of equities and other risky assets in Asia. Yields on the US 10-year bonds fell 3 basis points to 2.53 per cent.
But, later, German 10-year yields rose 15 basis points to 2.49 per cent as investors pulled out of what is seen as Europe’s safest financial asset.
“Bunds are falling big time,” said Peter Schaffrik, head of European rates strategy at RBC Capital Markets. “If the ECB is coming in to support the periphery we will less flight into German debt.”
Jean Claude Trichet, president of the ECB, welcomed the announcements from Italy and Spain of measures to accelerate their reforms, and promised to “actively implement” its revived bond-buying programme to intervene in eurozone bond markets, in a
statement issued on Sunday night after an emergency conference call of its governing council.
However, analysts said that action by policymakers would still have to be decisive and sizeable to ensure that Europe’s debt crisis does not deteriorate further.
“The question is the scale of the bond buying programme. If they are only doing small scale buying this rally will crumble quickly,” Mr Schaffrik warned.
Mark Schofield, head of interest rate strategy at Citi, said: “I’m not convinced it is enough to pacify the markets. There are still a lot of unanswered questions.”
Investors are concerned about the lack of firepower at Europe’s bail-out vehicle, the European Financial Stability Facility, which should take over bond-buying from the ECB in the autumn. They also point to the example of Greece last year when ECB purchases sparked a rally that fizzled out within days.
Mr Schofield said one problem was that the recent rise in Italian and Spanish yields had not been due to investors betting against the countries but rather selling out.
“It does encourage any manoeuvrable short positions to get out. But the market has been about a reduction in long positions not new short positions,” he added.
Analysts point to two big hurdles to the ECB buying bonds in huge amounts. One is how the ECB will sterilise its purchases. Mr Schofield suggests it might sell ECB debt. The second is whether and how the ECB can transfer its purchases to the EFSF.
The market impact of the ECB’s bond purchases could be lower than its previous intervention in Greece, Ireland and Portugal, given the larger size of the Spanish and Italian sovereign debt markets, Barclays Capital warned in a note.
Jacques Cailloux, chief European economist at Royal Bank of Scotland, told Bloomberg News he expected the ECB to buy on average around €2.5bn of bonds a day.
There was no indication of divisions within the eurozone central bank over the controversial move to support Italy and Spain, although close observers expected there had been continued resistance from the German Bundesbank.
The action was defended in the statement as designed “to ensure price stability in the euro area”, as part of ECB monetary policy.
The ECB council called for “decisive and swift implementation” by both Italy and Spain of their budgetary plans to curb their deficits and reduce external borrowing, in order to restore their credibility in the bond markets.
The council also welcomed the statement by Nicolas Sarkozy, French president, and
Angela Merkel, German chancellor, which appeared to back ECB bond-buying and promised prompt implementation of reforms that would allow the €440bn European Financial Stability Facility – the eurozone governments’ rescue fund – to intervene in bond markets in the future.
Gary Jenkins at Evolution argued that the US downgrade could have a bigger effect in Europe than in Washington, particularly if France were to lose its triple A status. That would complicate the structure of the EFSF enormously. The premium France pays to borrow over Germany hit a euro-era record last week.
Investors were divided about the impact of
Standard & Poor’s downgrade of the US to double A plus, but said that it heightened uncertainty in extremely fragile markets. “At the very least, it adds uncertainty to a very uncertain picture. I expect the market to fall quite a bit further,” said Graham Secker, equity strategist at Morgan Stanley.
The downgrade was “precipitous, wrong, and dangerous,” said Bill Miller, chairman of Legg Mason Capital. “At best, S&P showed a stunning ignorance and complete disregard for the potential consequences of its actions on a fragile global financial system.”
In a sign of the downgrade’s limited immediate impact, the Depository Trust & Clearing Corporation, a US securities clearing house, said it would not change its collateral rules in light of the S&P move.
Additional reporting by Robin Harding, Guy Dinmore, Claire Jones, James Politi, Quentin Peel, Rachel Sanderson and Jennifer Thompson
