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Bond Purchases May Reveal ECB’s ‘Stomach’ for Fight: Euro Credit

August 15, 2011

(See EXT4 <GO> for more on the sovereign-debt crisis.)

Aug. 15 (Bloomberg) -- The European Central Bank may have spent less last week to reduce Italian and Spanish bond yields than it did when it entered the Greek market over a year ago.

The ECB probably settled 15 billion euros ($21.4 billion) of bond purchases, according to the median estimate of 19 economists and strategists in a Bloomberg News survey. That compares with 16.5 billion euros spent during the first week of the ECB’s initial foray into Greek markets in May last year. The central bank will publish last week’s settled purchases at 3:30 p.m. today in Frankfurt.

“The ECB needs to make sure it does enough to prove it has the stomach for the fight,” said John Davies, a fixed-income strategist at WestLB AG in London, who estimates it spent 8 billion euros last week. “No doubt it would have been shock and awe on Monday, but probably less on the following days.”

The ECB was forced to start buying Italian and Spanish bonds on Aug. 8 after politicians failed to convince investors they could contain the region’s sovereign debt crisis. Ten-year yields in both countries, which had soared to euro-era highs, dropped by more than 100 basis points to about 5 percent.

When the ECB started buying Greek bonds last year, the 10- year yield fell to as low as 7.2 percent from more than 12.5 percent. Today, it was at 15.5 percent.

‘Sustained Basis’

“To restore confidence and stability, the ECB will have to be in there on a sustained basis,” said Peter Schaffrik, head of European interest-rate strategy at RBC Capital Markets in London. “I don’t think the ECB can get away without spending at least 100 billion euros on Italian and Spanish bonds.”

Together, the two countries have 2.2 trillion euros of outstanding debt, compared with 630 billion euros for Greece, Ireland and Portugal combined.

The difficulty for the ECB is the more it buys, the harder it may become to “sterilize” the purchases by absorbing the same amount from banks, a practice it employs to ensure the extra liquidity it creates doesn’t fuel inflation.

The ECB will today seek 7-day term deposits from banks to offset its bond purchases, which previously totaled 74 billion euros. That total will climb by the amount settled last week.

“We fear that the sterilization constraint will force the ECB out of the secondary market sooner rather than later,” said Carl Weinberg, chief economist at High Frequency Economics in Valhalla, New York. “If so, yields on Italian and Spanish bonds will jump in a heartbeat.”

ECB Split

ECB policy makers are divided over the bond-purchase program, which when introduced last year was intended as a temporary measure while governments prepared a response to the burgeoning debt crisis.

After a four-month hiatus, and over opposition from Germany’s Bundesbank, the ECB reactivated its Securities Markets Program on Aug. 4 as the crisis worsened.

It initially bought Irish and Portuguese securities in an apparent attempt to reward countries that are sticking to fiscal consolidation plans. Its failure to enter Italian and Spanish markets helped fuel a worldwide stock sell-off as fears for the global economy grew, increasing pressure on the ECB to act.

At the same time, central bankers are urging governments to quickly sign off on plans to enable Europe’s rescue fund, the European Financial Stability Facility, to take over the ECB’s bond-buying role.

‘Apparent Reluctance’

“Markets will remain nervous simply because of the ECB’s apparent reluctance to greatly widen its SMP holdings,” said Stephane Deo, chief European economist at UBS Securities LLC in London. “We are not convinced that relatively cautious action by the ECB will keep Italian and Spanish spreads under control.”

The cost of insuring Italian bonds against default for five years declined on Aug. 8 only to creep back up later. The credit default swap on Italian bonds rose to 353 basis points on Aug. 12 from 344 at the start of the week. The CDS on Spanish bonds rose to 353 basis points from 408 a week ago.

“This suggests the market is very uncertain, and doubts the ECB is able to control the situation,” WestLB’s Davies said.

Some economists said the ECB may have spent considerably more than the survey’s median estimate suggests. Forecasts ranged from 5 billion euros to 50 billion euros. ECB President Jean-Claude Trichet said on Aug. 8 that the purchases are “undoubtedly significant.”

“The information we have suggests the ECB might have spent 15 to 20 billion euros on the first day alone,” said Pavan Wadhwa, the global head of interest-rate strategy at JPMorgan Chase & Co in London, who estimates 30 billion euros of settled purchases for the week. “They have no choice really, given the size of the Italian and Spanish markets. Until the EFSF starts buying bonds, the ECB has no choice but to remain there.”

--With assistance from Paul Dobson, Gabi Thesing and Liam Vaughan in London and Christian Vits and Jana Randow in Frankfurt. Editors: Matthew Brockett, Mark Gilbert

To contact the reporters on this story: Jeffrey Black in Frankfurt at; Anchalee Worrachate in London at

To contact the editors responsible for this story: Craig Stirling at; Daniel Tilles at

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