The European Central Bank (ECB) stepped into bond markets yesterday, backing up a pledge to support Spain and Italy with the aim of averting financial meltdown in the eurozone, while the G7 and G20 offered soothing words to investors shaken by a historic downgrade of the US debt rating.
Spanish and Italian bond yields fell as traders said the ECB was broadening its bond-buying program to include debt issued by the bloc’s third and fourth-biggest economies, in the latest effort to staunch Europe’s sovereign debt crisis.
“They’re doing 20 to 25 million [euro] clips and they’re spreading it around the market,” a trader said. “We expect them to do billions today.”
Equity markets that had been in headlong retreat in Asia turned positive in Europe as G20 finance chiefs and central bankers pledged to take all necessary measures to support financial stability, growth and liquidity in a coordinated manner.
“We will remain in close contact through the coming weeks and cooperate as appropriate, ready to take action to ensure financial stability and liquidity in financial markets,” the G20, of which France is currently the president, said in a statement yesterday.
Spreads of Italian and Spanish bonds over German debt narrowed sharply, credit default swaps fell and Spanish and Italian stocks jumped more than 3 percent. The euro also extended gains.
It marked a reversal of mood from the fear that had gripped Asian markets earlier in the day, when similar pledges in a G7 statement had failed to calm investors who drove safe haven gold to a record atop US$1,715 an ounce, while share markets again headed south.
Investors also turned their attention to what the US Federal Reserve might say at its policy meeting today, fueling speculation it might soon have to consider a third round of quantitative easing (QE) to resuscitate the world’s richest economy.
After a rare Sunday night conference call, the ECB welcomed announcements by Italy and Spain of new deficit-cutting measures and economic reforms, as well as a Franco-German pledge that the eurozone’s rescue fund will take responsibility for bond-buying once it is operational, probably in October.
“The euro system will intervene very significantly on markets and respond in a significant and cohesive way,” a monetary source said.
The central bank had been reluctant to step up its buying of distressed debt, fearing it would be seen as a blank check to spendthrift governments.
Since the program began in May last year, it has bought just 80 billion euros of bonds, while Italy and Spain alone issue about 600 billion euros a year. Dealers said it would take a pledge to buy several hundred billion euros of debt to get ahead of contagion fears.
At the same time the G7 — the US, Britain, Canada, France, Germany, Italy and Japan — said it would take joint action if needed in foreign exchange markets because “disorderly movements ... have adverse effects for economic and financial stability.”
The G20 communique followed shortly after European markets opened.
Japan intervened to restrain its currency last week, while the Swiss National Bank surprised with a new round of easing as it fought a rapidly rising franc.
Pressure is now growing on the Fed to try further easing — dubbed QE3 by the market — though few expect anything dramatic as early as today’s policy meeting.