ECB pledge gets Spain, Italy rates down

FRANKFURT, Germany — A risky European Central Bank decision to fight the continent’s debt crisis by buying Spanish and Italian bonds on Monday started pushing down the soaring interest rates threatening those countries with financial disaster.

But some analysts cautioned that buying up the bonds of deeply indebted governments transfers significant risk to the balance sheet of an institution long reluctant to move beyond its traditional role controlling inflation.

Others warned that ECB reluctance to engage in the program risked a halfway effort that would led rates rise again disastrously. Bond yields and prices move in opposite directions; when purchases drive up the price, that reduces the interest rate countries would face if they issued new bonds.

The ECB has been reluctant to become directly involved in averting the crisis, instead pushing politicians to get their countries’ finances under control and give the (euro) 440 billion eurzone rescue fund the power to buy government bonds on the open markets.

But a recent spike in investor concern about Italy and Spain’s high debt levels and lackluster economic growth caught the 17-country eurozone just as parliaments broke up for the summer recess, delaying the crucial changes to the bailout fund known as the European Financial Stability Facility.

Most governments say they won’t be able to approve the expansion of the fund before September.

“For a democratic process with such heavy stakes, we cannot go any faster,” French Finance Minister Francois Baroin said on Europe-1 radio.

Left as the last line of defense, the ECB decided late Sunday decided to “actively implement” its bond-buying program, a crisis tool that it had so far not used for Italy and Spain.

The radical expansion of the ECB’s bond-buying program cements the bank’s unwilling role as the institution with primary responsibility for solving’s Europe 21-month-old financial crisis.

But some economists said the risk of Spanish and Italian default could soon return if the ECB hands off bond-buying to the EFSF, whose resources are fixed by eurozone leaders while the bank’s are, in theory, unlimted. Analysts at the Royal Bank of Scotland said they expected the central bank to buy an average of (euro) 2.5 billion worth of Spanish and Italian bonds each day, equivalent to (euro) 600 billion a year.

Analysts at Royal Bank of Scotland said the bank could wind up purchasing (euro) 850 billion ($1.2 trillion) of Spanish and Italian debt.

“You need somebody who is known to have unlimited firepower, and that’s what the ECB has,” said Paul De Grauwe, an economist at the Catholic University of Leuven. “There is no limit to the amount that the ECB can intervene. And once people see the central bank is ready to do this, they won’t need to do it. It’s an insurance mechanism.”

Economist Michael Schubert at Commerzbank thinks however that the bank would make purchases only until the EFSF was ready. He said the bank not only risked losses on the bonds, but its reputation as an inflation fighting monetary authority.

“If people do not believe or are convinced that the ECB is only responsible for monetary policy, but is in effect supporting governments, then this could be a severe loss in reputation and the consequences would be that inflation expecations would go up.”

Another analysts said the program falls short of contentious, long-term solutions such as issuing a joint eurobond, whereby the eurozone as a whole would borrow money in the markets. The problem for Germany is that it would pay higher interest rates under such a scheme.

A more drastic step, and controversial, step would be joint control over budgets.

“Small steps have been taken that may put off the future of the euro crisis for a couple of months but it seems to me we have the same issues to contend with,” said Simon Derrick, an analyst at The Bank of New York Mellon. “This is only over once they make the leap to fiscal union or someone leaves and the eurobond is a very strong step towards full fiscal union.”

In early afternoon trading Monday, the yield, or interest rate, on Italy’s 10-year bonds was down 0.61 percentage point to 5.39 percent while the equivalent rate on Spain’s tumbled 0.71 percentage point to 5.28 percent.

Italy’s and Spain’s borrowing costs rose to above 6 percent last week — rates that would strain the finances of eurozone’s third and fourth largest economies. The goal is to prevent them from an interest rate spiral like the ones that forced Ireland, Greece and Portugal to seek bailout loans from the eurozone and the International Monetary Fund.

Until now, the ECB had invested just under (euro) 80 billion ($113 billion) in Greek, Irish and Portuguese bonds.

That appeared to cushion the feared fallout from Standard & Poor’s decision last Friday to downgrade U.S. long-term debt.

In contrast to the bond-buying programs of the U.S. Federal Reserve and the Bank of England, the ECB “sterilizes” its bond purchases by withdrawing funds from the financial system so that the overall amount of money in circulation remains the same, warding off any inflationary effects.

The ECB’s decision to take a more active role came after both Italy and Spain announced new measures to cut spending and boost growth. Italian Prime Minister Silvio Berlusconi Friday night said that his country would work to balance its budget by 2013, a year earlier than planned.

Spanish Finance Minister Elena Salgado on Sunday announced new reforms aimed at bringing in an extra (euro) 5 billion to help achieve its goal of cutting its deficit to 6 percent of GDP this year.