BRUSSELS (MNI) – Showing clear signs of concern over recent
volatility in the Eurozone sovereign debt market, the European Central
Bank extended its liquidity operations and said it would continue buying
government bonds — though it stopped short of a commitment to increase
the magnitude of its bond purchasing program, which many market players
had been hoping for.

The central bank – which is grappling to balance a
stronger-than-expected recovery in the Eurozone economy with increasing
divergence between the core and peripheral countries – had been hoping
to withdraw some of the special liquidity support measures it introduced
to counter the financial crisis. But continued tension in sovereign debt
markets and volatility of the euro’s exchange rate continue to hold the
ECB hostage.

As ECB President Jean-Claude Trichet stepped up to speak at a press
conference after the December policy meeting, the market was a flurry
with speculation that he would unveil a more aggressive bond purchasing
strategy, increasing the amount that the ECB would buy or announcing
that the central bank would stop sterilizing its bond purchases and
embark on US-style quantitative easing.

What followed was fairly minimal, at least by current crisis
standards.

“Trichet tried to calm markets without giving them everything they
wanted,” ING Economist Carsten Brzeski said.

“The ECB will continue the fixed rate, full allotment procedure on
its liquidity operations at least for another quarter but it will not
engage in a Fed-style quantitative easing,” he added.

The ECB said it would leave its main policy interest rate unchanged
at 1%, in line with expectations, and keep all its non-standard measures
in place for the time being.

On the liquidity operations, Trichet said the ECB had decided to
maintain fixed rates and full allotment at its three-month and one-month
operations through the first quarter of next year. After that the
operations will be adjusted “as appropriate,” the ECB President said,
thus leaving the door open to another extension should markets still be
unstable when the time comes for the next decision.

Trichet also said the central bank would keep the main one-week
refinancing operation in full-allotment mode at least until April 12.

“Our judgement is that it is appropriate to pursue this
non-standard mode, taking into account the transmission of monetary
policy,” Trichet said.

And the ECB will also continue with its bond buying programme,
which was launched in May this year to prop up Eurozone debt markets, in
particular in high debt and deficit countries like Spain, Greece,
Ireland and Portugal.

Trichet said the programme – known as the Securities Market
Programme – was “ongoing” but he wouldn’t be drawn on whether or not it
would be ramped up or what the limit of ECB spending on bonds would be.

Perhaps tellingly, however, traders said the ECB was in the market
as Trichet spoke, aggressively buying bonds of the Eurozone’s peripheral
countries.

But Trichet nonetheless put the ball firmly back in the court of
Eurozone politicians, saying each of the 16 governments in the currency
union had a responsibility to act, reduce debt and deficits, and restore
investor confidence.

“While this [ECB] decision [not to expand the bond purchasing
program] is in line with our own expectations it comes as a
disappointment to some market expectations,” economists at Stockholm’s
SEB Bank said.

But even if the markets were expecting a broader or more aggressive
ECB programme, they seem satisfied for now. After the press conference,
Portugal’s 10-year sovereign bond spread was 53 basis points tighter
against the benchmark German Bund at +334 basis points, and Ireland’s
was 47 basis points tighter at +570 basis points.

“Considering that some market observers were speculating [about] a
more substantial announcement on the bond purchasing program, one could
have feared a very negative reaction in Euro area sovereign debt markets
following the somewhat disappointing message from the ECB. This was not
the case, however,” said Nordea’s chief markets analyst, Anders Matzen.

Whether the tensions will be alleviated over the coming days
remains to be seen, with the ECB remaining in a wait-and-see mode,
leaving the door open for increased bond purchases if needed but ever
hopeful that it won’t have to act more aggressively than it is now.

–Brussels: 0032 487 (0) 32 803 665, echarlton@marketnews.com

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