Successful bond auctions ease euro fears, for now

Published: Thursday, January 13, 2011 at 3:26 p.m.
Last Modified: Thursday, January 13, 2011 at 3:26 p.m.

LONDON — Hopes that European leaders may be about to strengthen measures aimed at dealing with the govermment debt crisis contributed to a strong euro rally Thursday as well as big declines in borrowing costs for financially troubled Portugal and Spain.

The sense that European Union leaders are ready to respond more quickly to events, following a year of procrastination and indecision, has been stoked by talk that Germany is now ready to back an increase in the size and powers of Europe's bailout fund, and to support a more active role from the European Central Bank.

Pledges of support from Japan and China have helped too.

No one is saying that the crisis is over, or that Portugal isn't going to join Greece and Ireland in needing an expensive bailout, but there has been a change of mood in the markets over the past few days. It may have to do with signs that Europe's policymakers have learned from their mistakes — particularly, the delays over the Greek crisis in the first half of 2010 — and are ready to be more proactive in dealing with the debt problems.

"They're still walking into walls but at least they know where the sticking plasters are now," said Simon Derrick, an analyst at Bank of New York Mellon.

Improved market sentiment was clear from the ease with which Spain and Italy managed to tap investors for money Thursday, a day after Portugal raised what it wanted — albeit a modest euro1.25 billion — without too much drama.

Spain raised euro3 billion via an auction of five-year bonds and investor demand, as with Portugal, was more than double what was being offered. And though the interest rate the Spanish government had to pay rose, it was not astronomical. The yield spiked to 4.542 percent from 3.576 percent the last time the bond with a 2014 maturing was offered, in line with developments in the bond markets following the stresses caused by the euro67.5 billion bailout of Ireland.

A similar picture emerged in Italy, which is considered less vulnerable in Europe's debt crisis than Spain.

The Italian government sold euro6 billion in medium- and long-term bonds, with room to spare. Again, though the yields on the two offerings spiked up higher than the last time, they were not seen as alarming.

In the wake of the auctions, the euro shot up over three cents to $1.3376, its highest level since Jan. 4, as the bond market pressure on countries like Portugal and Spain eased further. The yield on Portugal's 10-year bonds, for example, fell for the fourth straight day, to 6.719 percent, while Spain's dropped to 5.30 percent — though high, they're down this week.

Much of the improvement in the prevailing mood is due to expectations that Germany will back proposals to increase the capacity of the current bailout rescue fund — the so-called European Financial Stability Facility — as part of a package of measures designed to increase coordination among the euro's 17 countries.

European finance ministers will tackle longer-term solutions at a meeting in Brussels next week. Options include increasing the size of its bailout fund and charging countries that use it less interest and making it more proactive in its dealings with countries.

German finance minister Wolfgang Schaeuble indicated that a "comprehensive package" was under discussion so Europe will not constantly be in crisis mode.

"We're working on a comprehensive package so that we don't find ourselves in a situation every few months in which we have to start discussions all over again," Schaeuble told reporters Thursday in Berlin.

It seems like the mechanism being discussed is actually making sure that the current bailout facility has the full headline amount of euro440 billion to lend. In theory, that's what is in the pot — but the actual amount the EFSF can lend out is much smaller.

To get a triple-A credit rating, governments committed to guarantee 120 percent of the value of the bonds the fund issues. That means, the facility can only lend out a total of about euro367 billion. On top of that, bailed out countries have to deposit a certain portion of the loans they receive as a "as a cash buffer" with the fund.

Though many analysts believe Portugal will end up having to get a lifeline, as Greece and Ireland have had to, the real concern is stopping the crisis spreading to Spain. Emergency support for Spain would test the limits of the existing bailout fund, potentially putting the euro project in jeopardy if governments don't put up more cash. The country makes up over 10 percent of the eurozone economy, whereas Greece, Ireland and Portugal only account for around 2 percent each.

This fear of the debt contagion spreading to Spain is behind the talk of an increase in Europe's bailout fund as well as making it more proactive in dealing with the crisis.

European Central Bank president Jean-Claude Trichet said it's important that the bailout fund is improved "quantitatively and qualitatively" — code for, give it more money and more flexibility in dealing with potential sources of tension.

The European Central Bank itself is taking a more central role in the crisis.

Trichet told a press briefing after the central bank kept its main interest rate unchanged at the record low of 1 percent that a bond-buying program authorised at the time of Greece's euro110 billion bailout last May was "ongoing."

The ECB has been buying the bonds of the most indebted euro countries in the markets, which helps to raise their prices, taking pressure off the banks that hold them. It also lowers their yield, which represents the rate countries would pay if they went back to bond investors for more borrowing.

It may be small potatoes compared to what the Federal Reserve has been doing — the ECB's total spend is no more than euro75 billion, around an eighth of the Fed's current bond buying program — but it has been credited with easing tensions in Europe's bond markets, particularly those whose countries considered to be in the line of fire.


Colleen Barry in Milan, Daniel Woolls in Madrid, Juergen Baetz in Berlin and Gabriele Steinhauser in Brussels contributed to this story.

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