ECB defends bond market intervention

The president of the European Central Bank (ECB), Jean-Claude Trichet, has vigorously defended his controversial decision on Tuesday to buy up Italian and Spanish bonds, saying the European debt crisis held the potential for the worst market collapse in almost a century.

“It is the worst crisis since World War II and it could have been the worst crisis since World War I if leaders hadn’t taken important decisions,” Trichet said in an interview with French radio station Europe1.

As the borrowing costs of the latest countries to be caught up in Europe’s debt crisis fell for a second day running, Trichet implicitly confirmed that the ECB was behind a surge in purchases. “We are in the secondary market,” he acknowledged.

The rise in demand lifted the prices of Italian and Spanish bonds, cutting their yields, which represent the return to investors and the cost to the governments issuing them.

The news from the debt markets, however, did little to prevent turmoil on Europe’s stock markets, which extended their earlier heavy losses before climbing back in response to the positive opening on Wall Street.

Sentiment was initially depressed by the release of data showing a slowdown in German export growth. The Federal Statistical Office said exports in June were up 3.1% to €88.3-billion on the year, the lowest increase in 16 months. Since the introduction of the euro, Germany’s export-led economy has become even more crucial to European growth than it was before.

The Bank of France’s monthly industrial survey showed corporate order books and factory utilisation rates falling for the second month in a row in July. A slowdown in growth in the eurozone’s two core economies will only encourage speculation that they are next in line to be contaminated by the debt crisis.

Bloomberg reported that, for the first time in three years, the cost of insuring against a German default on its bonds had risen above the cost of insurance against a British default.

By early evening, the spread — or gap — between the yield on Spain’s benchmark 10-year treasury bonds and its notionally safe German equivalents had shrunk to 2.72%.

The spread on Italian bonds was down to 2.78%, reflecting a growing market perception that Italy, with its heavier debt and government that is apparently less keen on reform, carries higher risks.

Said Trichet: “In the past few days, we have asked the Italian government very clearly to take a certain number of decisions … and in particular to speed up the return to a situation of normal balance [between spending and revenue]. The same thing has been asked of the Spanish government.”

His remarks went some way towards confirming a report on Monday that he and his designated successor, Italian central bank governor Mario Draghi, had sent Italian Prime Minister Silvio Berlusconi a detailed “shopping list” of reforms they wanted in exchange for supporting Italy’s bonds.

On Friday, Berlusconi announced that he was bringing forward to 2013 the date by which he intended to eliminate Italy’s budget deficit.

Further evidence that the crisis is pushing the eurozone towards centralised policy-making came from Germany’s economy minister and vice-chancellor, Philipp Rosler. He proposed the creation of a new “stability council” that could penalise member states that lived beyond their means and oversee competitiveness tests, which could look at, among other things, the flexibility of labour markets. —

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