Speculation about ECB bond buying programme lifts battered euro, narrows spreads

The euro rose and borrowing costs for crisis-hit eurozone countries fell on Wednesday amid speculation the ECB could take decisive steps to combat turmoil that has stoked contagion worries in the US and Asia.

An 85 billion euro ($110.7 billion) EU-IMF rescue of Ireland last weekend and public assurances from European leaders that the euro will be defended at any cost have failed to impress investors who are targeting Portugal, Spain and Italy in a test of the EU’s resolve and crisis-fighting resources.

Reflecting global concerns about the eurozone crisis, the US Treasury announced late on Tuesday that it would send an envoy to Europe this week to discuss the turmoil with governments in Berlin, Madrid and Paris.

G20 sources also told Reuters that deputy finance ministers from the group of major rich and developing nations had discussed Europe’s financial plight in a conference call on Monday, although they described the call as routine.

A day after investors pushed the risk premiums on Spanish and Italian bonds to euro lifetime highs, speculation grew that the European Central Bank could unveil new anti-crisis measures after it meets on Thursday, including possibly new purchases of government bonds.

The obstacles to such a step are high. An ECB bond purchase programme launched in May after Greece was bailed out has been controversial within the bank, and influential Bundesbank head Axel Weber has called publicly for it to be scrapped.

The ECB declined to comment on the bond purchase speculation. But a rising number of economists say it may need to throw out its rule book to save the euro, particularly as governments seem to be running out of ideas to restore confidence in their bold 12-year old currency project.

“The moves we’ve seen over the last week or so have highlighted that something pretty serious needs to be done,” said Elisabeth Afseth of Evolution Securities.

“The country by country approach that’s been taken so far has failed to calm the markets. In the short term at least what is probably the easier option is for the ECB to step up their buying programme, buying up huge amounts of the peripherals, and the more core ... Italy.”

The euro edged higher on Wednesday, pushing above $1.31 after dipping to a 10-week low against the dollar on Tuesday.

The premium investors demand to hold Portuguese, Spanish and Italian bonds instead of German benchmarks fell and European bank stocks rebounded strongly after losses earlier in the week.    But Portugal saw its borrowing costs surge in a 12-month bill auction and a German 5-year note sale drew the weakest demand in over six months.

Manufacturing data highlighted economic divergences within Europe, and showed production in China and India charging ahead.    For a third day running, policymakers tried to reassure markets of their determination to stabilise the eurozone in the face of a debt crisis that has haunted it for a year, and in recent weeks raised doubts about the common currency’s future.

“We are all determined. We are all in a joint effort to achieve that stability within the zone,” said French economy minister Christine Lagarde.

Klaus Regling, a German official who heads the temporary rescue mechanism set up by the EU half a year ago, said in Singapore that speculation the euro would disintegrate was plain “wrong” and that no member would leave the bloc.

Still, in a reflection of how worried Europe’s partners have become, the US Treasury said it would send under-secretary for International Affairs Lael Brainard to Europe this week to discuss
the turmoil.

Citigroup chief economist Willem Buiter warned this week that eurozone turmoil may be the “opening act” of a global sovereign debt crisis that could infect the United States and Japan.

EU plans to make private bond holders shoulder some of the pain from any sovereign debt restructuring after mid-2013 have led investors to reassess the risk of putting their money in the government bonds of high-debt countries.

ECB president Jean-Claude Trichet warned markets on Tuesday against underestimating the determination of policymakers to stabilise the eurozone, but their options for stopping the rot appear limited.

Germany has resisted pressure from countries such as France to turn the eurozone into a “fiscal union” — a step which could help the bloc address its economic imbalances, but which would require members to sacrifice sovereignty over economic policy for the good of the group.

Chancellor Angela Merkel is also sceptical about putting up more funds for bailouts, concerned that German taxpayers would end up shouldering the lion’s share of a string of rescues of countries which Berlin believes have made themselves vulnerable through economic mismanagement.

Peter Bofinger, a member of the “wisemen” panel of economic advisers to the German government, said the risks to the euro were “enormously large” and Germany needed to decide whether it wanted to let the currency fail or do more to save it.

“For me it is decisive that we ask ourselves in Germany whether we want to continue to have the euro or not,” he told NTV television. “We must have this discussion because we must ask ourselves whether we find it worth it to stand up for it.”