Debt crisis prompts bond buying by ECB - Europe

The European Central Bank says it will be buying government bonds in response to a deepening debt crisis.

It has also offered a new round of liquidity to banks.

The decisions came after meetings to look at ways at cushioning the impact of the debt crisis that is threatening to spread to Italy and Spain and is also putting the future of the euro currency at risk.

Jean-Claude Trichet, the ECB president, suggested on Thursday that interest rates could rise further.

After the ECB decided at its monthly policy meeting to leave its main refinancing rate at 1.5 per cent, Trichet said the bank's bond-buying programme, which had been inactive since March, was still operational.

"I never said myself that it was dormant," Trichet said.

He said  the weekly ECB bond-buying data would show what actions had been taken by the central bank.

"It is an ongoing programme and we are totally transparent," Trichet said.

Traders said they saw the ECB buying Portuguese and Irish government bonds in the secondary market as Trichet spoke, although not those of Italy and Spain, which have also been hit hard by the debt crisis.

Economic morass

Three eurozone countries - Greece, Ireland and Portugal - have already had cash bailouts from the EU and the IMF as they remain stuck in deep economic morass due to the debt crisis.

The chief European economist for Standard and Poor's, Jean-Michel Six, said markets expect the ECB will reactivate its bond-buying operation to calm market turmoil.

"Markets are still moving so we need someone to intervene," he said.

"The only effective fireman capable of getting us out of the building quickly is the ECB which, since the beginning of the crisis, has played an admirable role to calm markets."

ECB bond purchases have been an effective way to stem panic or speculative selling of sovereign bonds that drives up the cost of borrowing for heavily indebted governments.

But the ECB suspended its purchases 18 weeks ago because they forced it to shoulder an increasing amount of risk that Trichet, insists should be borne by the governments themselves.

The ECB bought 76bn euros of sovereign bonds, believed to be only Greek, Irish and Portuguese, to stabilise markets last year but critics said the Securities Market Programme had only limited, short-term impact and did not prevent any of those countries from requiring EU/IMF bailouts.

However, sharp declines in Italian and Spanish government bond prices, sending yields to record highs in recent days, have prompted speculation that the ECB will opt to resume the programme to support the government's bond markets.

"A revival of the ECB's securities markets programme is the only real option that would prevent a liquidity crisis for Spain and Italy," Goldman Sachs economist Dirk Schumacher said.

The yield on Spain's 10-year bonds climbed as high as 6.5 per cent on Wednesday because of investor doubts
about Madrid's ability to continue financing its debt over the long term.

Italy's 10-year yield fell back below the 6.0 per cent threshold, with some traders saying they expected the ECB could act, either with a longer term repo or secondary market bond-buying.

Need for baillout

Analysts say that if yields go much higher and stay there, markets could force Spain, the eurozone's fourth biggest economy, to follow Greece, Ireland and Portugal in seeking an international bailout.

Euro zone leaders agreed at a summit last month to give the bloc's bailout fund sweeping new powers to help indebted states and intervene in the bond market.

But the changes are unlikely to be passed by national parliaments until late September at the earliest.

The ECB is expected to leave its key refinancing rate unchanged at 1.5 per cent, after raising rates twice since April.

The outlook for global interest rates has swung away from the sort of steady tightening begun by the ECB earlier this year and the bank meets just a day after Switzerland delivered a shock cut in its already very low rates.

The Bank of Japan also eased monetary policy by boosting asset purchases on Thursday and conveyed its determination to support Tokyo's solo currency intervention to weaken the yen.