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ECB Pares Spanish, Italian Bond Purchases, AFME Says

The European Central Bank has trimmed purchases of Spanish and Italian bonds after a government-led financial lifeline for the euro region shored up investor confidence in debt markets, said Sander Schol, a director of the Association for Financial Markets in Europe.

“Central banks are buying less Spain and Italy,” Schol, whose division represents the region’s 20 primary dealers, said in an interview yesterday. “That might mean that they think that the markets in these countries have stabilized enough that they don’t have to intervene. They’re narrowing their focus.”

The central banks of Germany, France and Italy intervened in debt markets on May 10, three days after bond dealers pleaded with the ECB to step in and stop a debt-market rout that sparked concerns about the euro’s future. Bonds have since stabilized across the euro region, indicating that the plan is working and will give governments more time to cut their budget deficits.

Schol said most of the ECB’s bond purchases seem to have been made on May 10, the first day the rescue plan was in force, and buying has diminished since then. Executive Board member Jose Manuel Gonzalez-Paramo said yesterday the ECB will explain next week how it plans to sterilize its purchases. An ECB spokesman declined to comment on Schol’s remarks.

Purchases yesterday were “pretty quiet” because there’s a holiday in many European countries and market conditions are better, said Schol. Central banks spent around 7 billion euro ($8.8 billion) on Monday, 5 billion euros on Tuesday, 4 billion euros on Wednesday and between one and two billion euros yesterday, ING Groep NV estimated in a research note today.

Call With ECB

“The levels of distress we saw on the market last week have clearly improved because of the ECB,” he said.

Italy sold debt at lower yields than existing securities yesterday. It auctioned 2 billion euros of bonds maturing in 2025 at an average yield of 4.42 percent, compared with about 4.5 percent before the auction.

Schol said his members told the ECB on a May 7 conference call that central bank purchases of debt were vital to stemming the crisis. As a representative of primary dealers, his members had been informing him during the week that strains in the market were spiraling out of control, said Schol, who was on the ECB call.

‘No Buyers’

“From around Tuesday and Wednesday last week we started hearing feedback from our members that the situation was getting out of hand, that what started in Greece spread to Portugal then to Spain, Ireland and Italy,” he said. “These were the markets where the concerns were, and there just were no buyers, everyone was selling.”

His organization informed national finance ministries of the situation by emailing their debt management offices on May 5 and 6. In the late afternoon of May 7, he and a colleague had a call with a European Commission official to make the EU’s executive arm aware of the problem.

At 5:30 p.m., Schol, some colleagues, and representatives of primary dealers arranged a call with about five ECB officials to make them aware of the turmoil and to discuss a solution.

“We made clear to them that it was really necessary to step into the markets,” he said. “There were no buyers at that point. We felt that if the ECB would announce that they would operate as a buyer, the markets would know there was a floor to the prices.”

ECB Receptive

Central bank officials were receptive to the comments, without revealing their plans, he said.

“They were really open, but these guys made it clear from the outset, we will listen very carefully, but we will not give any hints on the direction of policy,” Schol said. “If they did, then people on the call could make use of the information.”

The group discovered that their request had been put in place on May 10, when the ECB announced its plans in a press release published at 3:15 a.m. Frankfurt time.

Soaring yields threatened to shut Spain and Portugal out of debt markets and sparked a weekend of talks with euro-region finance ministers and central bankers. The result was a 750 billion-euro ($940 billion) financial aid package.

The extra yield that investors demand to hold 10-year Spanish bonds over German bunds has narrowed 74 basis points to 99 basis points since touching a euro-era high on May 7. Spreads on Italian debt have narrowed 67 basis points to 92 points.

El Erian

Some investors nevertheless argue that European governments need to take more action to cut budget deficits before the crisis abates. Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., said in an interview with Bloomberg Radio yesterday that the euro won’t reverse a decline in value until there is a “sustainable solution” to Europe’s debt burden.

Former Federal Reserve Chairman Paul Volcker said yesterday that he’s concerned the euro area may break up.

“You have the great problem of a potential disintegration of the euro,” Volcker said in a speech in London. “The essential element of discipline in economic policy and in fiscal policy that was hoped for” has “so far not been rewarded in some countries.”

The euro has declined 12 percent this year and has dropped below its level before last weekend’s agreement. It slipped 0.3 percent to $1.2579 yesterday, and was little changed today, fetching $1.2542 at 1:49 p.m. in Tokyo.

Spanish Prime Minister Jose Luis Rodriguez Zapatero this week announced the biggest round of budget reductions in 30 years. In Portugal, Finance Minister Fernando Teixeira dos Santos says he’s prepared for “social tension” and announced additional steps to cut the country’s budget deficit yesterday.