FRANKFURT (MNI) – Bond yields in both Italy and Spain fell sharply
on Monday as the European Central Bank bought Italian and Spanish
government bonds after promising to “actively implement” its bond-buying
program on Sunday night.

While the ECB’s decision to expand its program to include paper of
the Eurozone’s third and forth largest economies was certainly welcomed
by markets, concerns quickly emerged about how sustainable the reprieve
may be.

Any longer-term solution to Europe’s debt troubles certainly
remains in the hands of governments, whose action remain painfully slow.

After governments’ inadequate policies took the crisis to a fresh
peak, the ECB was once again forced to act as the last line of defence.
According to market talk, the ECB has bought some E5 billion in Italian
and Spanish debt.

In doing so, the central bank is moving into increasingly
uncomfortable territory: it not only had to resume its controversial
bond buys, but also had to include countries that are not under a rescue
program forcing them to pursue tough adjustment measures.

In a bid nevertheless to keep up pressure on governments, Sunday
night’s statement said the decision to intervene came on the basis of on
a number of things, including new measures in Italy and Spain and
governments’ readiness to activate the ability of the European Financial
Stability Facility (EFSF) to intervene in the secondary market.

The words sound all too familiar. When the ECB first launched its
bond-buying program, it did so only after taking note “of the statement
of the euro area governments” that assured rapid adjustment measures.
Governments clearly failed to live up to their promises last time.

The big question is whether governments have learned their lessons.

German Chancellor Angela Merkel and French President Nicolas
Sarkozy in a joint statement issued on Sunday reiterated their
commitment to fully implement the decisions to solve the European
sovereign debt crisis taken by Eurozone leaders on July 21.

However, the German government quickly dashed hopes that the ECB
may not be alone in stepping up its crisis-fighting measures. “Nothing
changes from the agreements reached on July 21,” said government
spokesman Christoph Steegmans.

But precisely that may be needed to make the ECB’s intervention
successful and ensure a more permanent solution to the debt crisis.

The ECB’s long-standing concerns over the bond buys and its push
for the EFSF’s ability to intervene in the secondary market raises the
question whether the central bank will continue to pursue what it
considers the responsibility of fiscal authorities once they are
technically able to take over.

“Any signal that the ECB is only intervening on an interim period –
that is until the EFSF is up and running – will give the market a
sentiment that there is a finite limit on purchases (that of the EFSF
buying power),” RBS’s chief Europe economist Jacques Cailloux said in a
research note.

That finite limit is E440 billion, which is the EFSF’s current
firepower. Germany’s quick rejection of European Commission President
Jose Manuel Barroso’s proposal to boost Eurozone rescue fund coupled
with today’s insistence that nothing has changed does not suggest an
increase will come soon.

Even if the central bank continues to buy bonds once the EFSF
reform is in place, there are question marks about whether the ECB
itself will be able and ready to intervene significantly enough to keep
spreads down.

Given the size of Italy and Spain, “it could be difficult for the
Eurosystem to engage in purchases of significant enough size in order to
arrest the upwards shift in spreads and yields,” said Barclays Capital
European economist Julian Callow in a research note. Italy plans to
issue debt worth about E100 billion this year.

Opposition of some ECB Council members to purchasing debt may mean
that the central bank’s attempt to do so could be half-hearted.

Even the decision to resume buys for countries under a bailout
program had seen some resistance on the Council. The fact that last
night’s statement came from Trichet rather than the ECB may be a sign of
significant dissent on the Council to Italian and Spanish purchases.

Still, Sunday’s decision once again showed that when push comes to
shove, the majority of Council can be relied on to push through further
action. But there is also little doubt that none of these actions offer
a long-term solution. Only governments can solve this crisis.

–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com

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