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Draghi Stuck With Trichet’s ‘Temporary’ Bond Plan: Euro Credit

European central bank President Mario Draghi
Mario Draghi, president of the European Central Bank (ECB), center. Photographer: Scott Eells/Bloomberg

The European Central Bank’s bond program, dubbed “temporary” by Jean-Claude Trichet, shows no signs of ending even after 219 billion euros ($289 billion) of purchases augmented by twice as much in three-year loans.

The ECB, led by Mario Draghi since he replaced Trichet on Nov. 1, has bought bonds for its Securities Market Program every week since August. Even after handing banks 489 billion euros that they don’t have to repay until the end of 2014, the central bank will need to spend as much as 15 billion euros per month to cap yields, said Nikolaos Panigirtzoglou, European head of global asset allocation at JPMorgan Chase & Co. in London.

“The ECB will not stop the SMP program,” Panigirtzoglou said. “It is a valuable and flexible tool.”

Italy’s 10-year bond yield fell 10 basis points today to 5.99 percent, down from a euro-era high of 7.48 percent reached Nov. 9. Three-year yields were at 4.37 percent, compared with more than 7.9 percent 10 weeks ago.

The central bank revealed the so-called SMP initiative in May 2010 to “ensure depth and liquidity in those market segments, which are dysfunctional.” A month later, Trichet said purchases would be temporary, without providing further information. A five-month pause in 2011 ended when transactions jumped to 22 billion euros in the week to Aug. 12 as surging borrowing costs in Italy and Spain spurred ECB buying.

Maturity Mismatch

While two-year yields for Spain and Italy have dropped by more than 2 percentage points since the ECB said Dec. 8 it would offer unlimited three-year cash, rates on bonds repayable after the period covered by the loans have stayed high. The yield gap between two-year and 10-year Spanish debt is about 239 basis points, up from as low as 61 basis points on Nov. 25. The spread in Italy’s bond market is 239, after two-year notes briefly yielded more than 10-year debt in November.

Italy failed yesterday to sell its maximum target of 8 billion euros of bonds due between 2016 and 2022. Non-European investors may invest the proceeds of maturing euro-denominated debt elsewhere, according to Laurent Fransolet, head of fixed-income strategy at Barclays Capital in London.

“I think they continue, if that is the more convenient solution as a backstop,” Fransolet said in an e-mailed response to questions about the central bank purchases. The ECB has probably made a profit on Italian and Spanish debt, and both nations are delivering reforms to cut their budget deficits, so it “must be willing to continue,” he said.

Portuguese Yields Climb

The ECB bought Portuguese bonds yesterday as 10-year borrowing costs climbed to a euro-era record, said three people with knowledge of the transactions, who declined to be identified because the trades are private. Portuguese bonds repayable in April 2021 snapped a four-day decline today, leaving yields at 17.01 percent. The rate has climbed from about 13.4 percent at the start of the year.

Greek debt has continued to decline even as the ECB has invested in the securities, driving two-year notes to less than 21 percent of face value from more than 90 percent in May 2010.

Draghi’s stance on ECB bond purchases will be scrutinized after the policy contributed to the resignations of former Bundesbank president Axel Weber and Executive Board member Juergen Stark. Weber, who was seen as a leading contender to replace Trichet at the central bank, said the program posed “stability risks” and there was no evidence it worked.

Remaining Responsible

Bond purchases aren’t eternal or infinite, Draghi said on Jan. 19. The ECB is seeking alternatives to buying bonds, Governing Council member Ewald Nowotny said, according to a Jan. 17 Wall Street Journal report. An ECB spokesman in Frankfurt declined to comment on the bond-buying arrangements.

The central bank said yesterday it settled 63 million euros of bond purchases in the week through Jan. 27, the lowest amount in a month and down from 2.2 billion euros the previous week.

The scope for ECB policy makers to cede responsibility to the European Financial Stability Facility bailout fund is fading, according to Achilleas Georgolopoulos, a fixed-income strategist at Lloyds Bank Corporate Markets in London.

“They don’t really like the SMP, but they know it’s necessary,” he said. “All the extra measures they announced for the EFSF are still not in place. It cannot intervene, and if it cannot intervene, then the ECB will remain active.”

Resorting to the EFSF for aid would probably carry a “stigma” that Spain and Italy are keen to avoid, said Elisabeth Afseth, a fixed-income analyst at Investec Capital Markets in London.

“The ECB has a less formal agreement with countries,” she said. “It would undoubtedly like to stop if it felt there was no further need for its interventions. We are still some way away from that.”

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