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Euro-Area Central Bank Chiefs Race to Curb Italy, Spain Contagion in Call

European Central Bank officials held emergency talks today as governments pressured them to buy Spanish and Italian bonds to stem the worsening debt crisis.

The central bank chiefs met by conference call, said a euro-area central bank official who declined to be identified because the talks are confidential. A spokesman for the ECB declined to comment. Officials from the Group of 20 held a call earlier today and G-7 finance chiefs, including U.S. Treasury Secretary Timothy Geithner, are set to confer later today.

The flurry of talks comes as the first U.S. credit-rating cut in history by Standard & Poor’s threatens to further derail efforts to stop the debt crisis from engulfing the euro area’s third and fourth-largest economies.

“Europe is in an incredibly dangerous situation,” Nick Kounis, head of macroeconomic research at ABN Amro in Amsterdam, said in an interview by telephone yesterday. “The risk is that the U.S. downgrade is just going to unsettle everyone even more. It’s a unique situation in that we are essentially in the heart of a European sovereign debt crisis, which has reached its meltdown phase.”

A week that European leaders intended to spend on vacation ended with S&P cutting the U.S. credit rating by one level from AAA, hours after an unscheduled appearance from Italian Prime Minister Silvio Berlusconi, who pledged further austerity and to balance Italy’s budget in 2013. He suggested an emergency G-7 meeting may convene to tackle a crisis that has cast doubt on the sustainability of his nation’s 1.8 trillion-euro ($2.6 trillion) debt load.

Merkel, Sarkozy

In a joint statement issued while ECB policy makers were in talks, French President Nicolas Sarkozy and German Chancellor Angela Merkel called for their parliaments to approve by the end of September the July 21 agreement on strengthening the euro area’s bailout fund. They also praised steps by Spain and Italy to strengthen their public finances.

The planned G-7 call is expected to focus on how to calm markets roiled by the European crisis and U.S. downgrade. The finance chiefs may release a statement after the call, Kyodo News Service reported.

European stocks posted their biggest weekly loss since November 2008, becoming the first major region to enter a market correction. The Stoxx 600 Europe Index tumbled 9.9 percent to 238.88, the gauge’s lowest level in 13 months.

Political Pressure

Italian and Spanish bond yields rose relative to benchmark German bunds for a second week. Ten-year borrowing rates for both nations reached the most since before the euro was introduced in 1999. The U.S. rating cut may prompt further flows of funds into German government bonds, ABN Amro’s Kounis said.

As bond markets reopen tomorrow, investors may look for clues on whether the ECB will expand purchases after it resumed its emergency debt-buying program on Aug. 4 following an 18-week hiatus. It acquired Irish and Portuguese securities and has so far avoided the Spanish and Italian bond markets.

The ECB’s reluctance to buy Italian bonds is discouraging demand for the country’s debt, Finance Minister Giulio Tremonti said last week.

“The ECB must do its duty and help stability on debt markets,” Spanish Finance Minister Elena Salgado told EFE in an interview. The finance ministry confirmed the comment.

Such a move would take place against the backdrop of the nation managing the world’s most-important reserve currency no longer being the highest-rated sovereign.

‘Unique Case’

“In past events, when we’ve seen a triple-A downgrade the impact on bond markets has not been extremely large,” ABN’s Kounis said. “But this is a unique case with the world’s major reserve currency.”

S&P lowered the U.S. one level to AA+ while keeping the outlook at “negative.” The rating may be cut to AA within two years if spending reductions are lower than agreed, interest rates rise or “new fiscal pressures” result in higher general government debt, the New York-based firm said.

“It’s not easy to assess the impact of the U.S. downgrade, but it’s clear that it comes at the wrong time,” said Marco Valli, chief euro-region economist at UniCredit Global in Milan. “It’s easy to understand that the market won’t like it.”

Paul Donovan, deputy head of global economics at UBS AG, said that the downgrade’s impact may still be limited because the standoff in Congress on raising the U.S. debt ceiling had braced officials for such an event.

“The downgrade is unlikely to have a significant impact on bond yields,” Donovan said. “It is one of three credit rating agencies, and the world’s central banks have been prepared for this with the debt ceiling debate.”

AAA Ratings

Investors seeking a haven amid concerns the global economic rebound is fading have bought Treasuries in recent weeks, even after S&P warned it may lower the U.S. rating. Yields on benchmark 10-year notes closed at 2.56 percent Aug. 5, before S&P announced the downgrade, down from 3.12 percent a month ago.

The S&P decision went further than Moody’s Investors Service and Fitch Ratings, which affirmed their AAA ratings for the U.S. on Aug. 2, the day President Barack Obama signed a bill that ended the debt-ceiling impasse that pushed the country to the edge of default. Moody’s and Fitch both said that downgrades were possible if lawmakers fail to enact debt-reduction measures and the economy weakens.

S&P currently gives 18 sovereign entities its top ranking. The U.K., with a debt estimated at 80 percent of GDP this year, 6 percentage points higher than the U.S., also has the top credit grade. In contrast with the U.S., its net public debt is forecast to decline either before or by 2015, S&P said in a statement.

New Zealand is the only country other than the U.S. that has an AA+ rating from S&P and an Aaa grade from Moody’s. Belgium has an equivalent AA+ grade from S&P, Moody’s and Fitch.

The rating cut puts the U.S. in an expanding club of Western nations from Greece to Spain whose deteriorating credit quality has provoked downgrades in the past year. Italy also faces such a threat, according to a statement from S&P in July.

To contact the reporters on this story: Jeffrey Black in Frankfurt at jblack25@bloomberg.net; Craig Stirling in London at cstirling1@bloomberg.net

To contact the editor responsible for this story: Andrew Davis at abdavis@bloomberg.net

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