ECB steps up emergency bond purchases

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The European Central Bank has stepped up its efforts to shore up eurozone debt markets by buying another €10bn of government bonds in the last week but bankers expect the programme will have to be intensified amid continued market fragility.

The purchases - announced on Monday - bring the ECB’s bond-buying to about €26.5bn since it announced the unprecedented programme two weeks ago, in support of a €750bn “shock and awe” rescue package adopted by eurozone governments and the International Monetary Fund to try to arrest a gathering sovereign debt crisis.

So far the policy has had a limited effect, with confidence in the eurozone further hit by last week’s surprise German ban on some types of short-selling.

Market participants say nervous international investors are likely to sell at any sign of uncertainty or doubts over the eurozone economy and bond markets, suggesting the ECB will have to intervene regularly over the coming weeks.

Traders say the bulk of the buying by the ECB last week followed the German decision to ban naked short selling on stocks and eurozone government bonds, which spooked the markets and led to sharp falls in the euro.

Gary Jenkins, head of fixed income research at Evolution, said: “The ECB was forced into the market after the German move to steady investors’ nerves. It shows how vulnerable the market is to a sell-off and how the ECB may have to intervene a lot more over the coming weeks and months.”

The most recent bond purchases extend a dramatic ECB policy U-turn this month in the face of what it said were “dysfunctional” markets, a result of fading confidence in Greece and other heavily indebted eurozone countries. Buying government bonds was an emergency step that the ECB was highly reluctant to take, fearing it would compromise the bank’s independence and thus damage its credibility.

The bank has not said which bonds it is buying, nor revealed a target amount. It revealed a week ago that its bond purchases in the first week of the programme amounted to €16.5bn.

With trading volumes in government debt extremely low as many investors sit on the sidelines because of the uncertain economic outlook, it only takes a few trades to send the market sharply lower. This in turn could prompt further selling as confidence is eroded, bankers say.

With a combined €2,400bn in outstanding government debt of Portugal, Greece, Spain, Italy and Ireland – the peripheral eurozone economies – investors say the ECB may have to buy up to €600bn.

This would raise question marks over the central bank’s ability to “sterilise” these purchases – draining an equivalent amount of money from the system by taking deposits from commercial banks, which the ECB is doing on a weekly basis.

By sterilising the bond purchases the ECB hopes to ensure the policy remains neutral in terms of impact on the money supply and the bank’s monetary policy. It wants to avoid so-called “quantitative easing” - expanding the money supply and thus stoking inflation, as some of the ECB’s more hawkish members fear.

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