Italian Bonds Slump as Investors Doubt ECB ‘Firepower;’ German Notes Climb

Italian bonds slumped, sending 10- year yields toward a euro-era record, as European Central Bank debt purchases failed to reassure investors that officials in the region have found a solution to the fiscal crisis.

The cost of insuring Italian debt surged to a record, with credit-default swaps rising 18 basis points to 384, according to CMA in London. German two-year notes rose after European Central Bank President Jean-Claude Trichet said the ECB will offer banks more cash as the debt crisis spreads. Irish securities jumped as Trichet signaled policy makers revived a bond-buying program.

With Italian bonds lower, so far the ECB’s action “doesn’t appear to have had the desired effect,” said Eric Wand, a strategist at Lloyds Banking Group Plc in London. “The market doesn’t think they have the firepower.”

The yield on 10-year Italian bonds rose 11 basis points to 6.19 percent at 4:58 p.m. in London. The yield reached 6.26 percent yesterday, the highest since 1997. The 4.75 percent security maturing in September 2021 fell 0.75, or 7.5 euros per 1,000-euro ($1,415) face amount, to 89.94.

The additional yield, or spread, that investors demand to hold 10-year French bonds instead of benchmark German bunds widened to as much as 87 basis points, the most since the euro was introduced in 1999. The Belgian 10-year yield spread also reached a euro-era record, climbing to 221 basis points.

ECB Purchases

Prime Minister Silvio Berlusconi urged Italians not to be “scared” by surging bond yields, saying the country will weather the market storm, after meeting with executives, bankers and unions on the economy.

The ECB bought Irish and Portuguese debt, according to three people with knowledge of the transactions, who asked not to be identified because the trades are confidential. Trichet said subsequently at a press conference in Frankfurt that the ECB’s governing council wasn’t unanimous in voting for a resumption of bond buying.

The yield on the Irish 10-year bond slid 24 basis points to 10.40 percent, while the two-year note yield plunged 32 basis points to 14.11 percent. The Portuguese two-year yield tumbled 50 basis points to 14.80 percent.

The ECB will lend euro-area banks as much money as they need for six months and extend its existing liquidity measures through the end of the year, Trichet said. The central bank held its benchmark rate at 1.5 percent today, as predicted by all 54 economists surveyed by Bloomberg News.

The German two-year yield tumbled as many as 21 basis points to 0.83 percent. The intraday decline was the steepest since July 11.

Liquidity Measures

Euribor futures rose, pushing the implied yield on the contract expiring in June 2012 down 21 basis points to 1.37 percent as traders scaled back bets that the ECB will increase borrowing costs further.

“The ECB says there is a need for an additional six-month tender and the markets are reading that as a sign that the ECB is concerned,” said Kornelius Purps, a fixed-income strategist at UniCredit SpA in Munich. “This is the reason why the front end of the German yield curve is crashing. We are going to be living in an environment with lots of liquidity.”

The 10-year bund yield reversed an initial jump after Trichet announced the liquidity measures, sliding as much as 12 basis points to 2.29 percent, an almost 10-month low. The bund gained for the 10th straight day, the longest run of increases since August 2005.

Not Unanimous

The rebound by bunds was due to Trichet’s comment on the vote not being unanimous, according to Nick Stamenkovic, a fixed-income strategist at RIA Capital Markets Ltd. in Edinburgh.

“Investors are uncertain of the extent of buying, particularly given differences of opinion within the council,” he said. “It is too early to expect a sustained fall in Italian and Spanish yields.”

Spanish 10-year yields rose three basis points to 6.28 percent, while credit default swaps rose six basis points to a record 424.

Spain’s borrowing costs rose as it sold 3.31 billion euros of three- and four-year notes at an auction today, compared with its maximum target of 3.5 billion euros, the country’s central bank said.

The 4.813 percent average yield on the notes due in 2014 compares with a yield of 4.291 percent paid on securities maturing in October 2014 at an auction on July 7. Spain drew bids for 2.14 times the securities on offer, compared with a so- called bid-to-cover ratio of 2.29 at the previous sale. The January 2015 debt drew bids for 2.4 times the 1.1 billion euros of debt that were sold at an average yield of 4.984 percent.

Bond Returns

Spain will sell a new five-year benchmark government note on Sept. 1, and will cancel a bond auction scheduled for Aug. 18, the Tesoro Publico said today in a statement on its website.

German bonds handed investors a 3.8 percent return this year, compared with 5.2 percent for Treasuries, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Italian bonds have lost 4.5 percent, while Portugal’s have fallen 24 percent, the indexes show. Spanish bonds lost 0.9 percent.

To contact the reporter on this story: Lucy Meakin in London at lmeakin1@bloomberg.net.

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net.

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