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Italy, Spain Lead Drop in Debt Risk on ECB Bond Buying Bets

Italy and Spain led a decline in the cost of insuring against losses on European government debt on speculation the European Central Bank will boost bond purchases to calm markets.

Credit-default swaps on Belgium, Portugal and Ireland also fell from record high levels, helping to push down the region’s benchmark index of sovereign swaps from an all-time high. A gauge of subordinated bank debt risk dropped from a 20-month peak.

Investors are hedging bets bonds will fall after ECB President Jean-Claude Trichet signaled policymakers may step up their response to the region’s debt crisis when they meet tomorrow. The ECB bought Irish and Portuguese government bonds today, according to traders with knowledge of the transactions.

“In the current environment, this is likely to be the only way to calm markets and extinguish the contagion fire,” said Stefan Kolek, a Munich-based strategist at UniCredit SpA. “We wouldn’t be surprised to see the ECB announcing a massive bond-buying program, which would represent de facto bail-out of governments through ECB money. In a later stage, the ECB and governments should elaborate steps to restore their credibility, moving towards a common fiscal policy and dealing with the debt burden.”

Credit-default swaps on Italy tumbled 41.5 basis points to 226.5, and Spain decreased 46 to 318, according to data provider CMA. Belgium declined 13 basis points to 192, Greece dropped 36.5 basis points to 928.5, Ireland was down 48 at 558, while Portugal was 63 lower at 479. The Markit iTraxx SovX Western Europe Index of swaps on 15 governments declined 12 to 189.

Financial Index

The Markit iTraxx Financial Index linked to the senior debt of 25 banks and insurers fell 10.5 basis points to 161 and the subordinated index dropped 27 to 284.5, according to JPMorgan Chase & Co.

Contracts on the Markit iTraxx Crossover Index of 50 companies with mostly high-yield credit ratings declined 25 basis points to 501. The Markit iTraxx Europe Index of 125 companies with investment-grade ratings decreased 5.5 basis points to 112, JPMorgan prices show.

A basis point on a credit-default swap contract protecting 10 million euros ($13.1 million) of debt from default for five years is equivalent to 1,000 euros a year.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A decline signals improvement in perceptions of credit quality.

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