Spanish, Italian Notes Rise on Bets for ESM Enhancement

Spanish, Italian Notes Rise on Bets ECB May Enhance Rescue Fund
Spain’s two-year yield fell eight basis points, or 0.08 percentage point, to 6.82 percent at 9:45 a.m. in London after climbing to 7.147 percent, the highest since 1996. Photographer: Angel Navarrete/Bloomberg

Spanish and Italian bonds rose on speculation the European Central Bank will augment the firepower of the region’s bailout fund as policy makers step up efforts to contain contagion from the debt crisis.

Spain’s two-year note yield fell from a euro-era record after ECB council member Ewald Nowotny said there are arguments in favor of giving the European Stability Mechanism a banking license, enabling it to borrow from the central bank. German bunds dropped for a third day as the nation sold 2.32 billion euros ($2.81 billion) of 30-year debt at a record-low yield. Business confidence in Europe’s biggest economy slid to a two-year low in July, an industry report showed.

“The idea of making the ESM a bank is a game changer,” said Vincent Chaigneau, global head of interest-rate strategy at Societe Generale SA in Paris. “The ECB has been against ideas like this. It is probably possible, the question is whether it can get enough political support. It remains a very political question.”

Spain’s two-year yield fell 47 basis points, or 0.47 percentage point, to 6.42 percent at 4:41 p.m. London time, after climbing to 7.147 percent, the highest since September 1996. The 4.75 percent note due in July 2014 climbed 0.855, or 8.55 euros per 1,000-euro face amount, to 96.955. The 10-year yield declined 25 basis points to 7.38 percent.

The yield on two-year Italian debt dropped 11 basis points to 4.94 percent. The nation’s 30-year bond rate climbed above 7 percent for the first time since January, before falling 11 basis points to 6.84 percent.

‘Ongoing Discussion’

Granting a banking license to the ESM would give it access to ECB lending, easing concern the bailout fund’s 500 billion-euro of cash reserves won’t be enough should Spain or Italy require aid.

“There are pro arguments for this,” Nowotny, who heads Austria’s central bank, said in an interview in his office in Vienna yesterday. “There are also other arguments, but I would see this as an ongoing discussion,” he said, adding he’s “not aware of specific discussions within the ECB at this point.”

Spain’s five-year yield climbed as much as 19 basis points to 7.79 percent earlier today, putting it briefly above the 10-year rate at 7.75 percent. The so-called inversion of the yield curve signaled concern that Spain may struggle to raise funds to pay its bills.

“Spain is in danger of being locked out of the markets,” said Owen Callan, a Dublin-based analyst at Danske Bank A/S. “These yields are at completely unsustainable levels. The market is worried that the Spanish state is going to have to support its regions and therefore the amount of funding that Spain needs in the market is going to increase.”

Deeper Integration

German Finance Minister Wolfgang Schaeuble and Spanish Economy Minister Luis de Guindos said Spain’s borrowing costs don’t reflect the strength of its economy as they pledged to work toward deeper integration to fight the debt crisis after a meeting yesterday.

The Spanish government today denied an El Economista report that Germany is urging Spain to request a 300 billion-euro bailout package that would erase the need to sell debt to investors for as many as two years.

Ten-year Spanish yields may rise high as 9 percent after breaching a level of resistance at 7.70 percent, analysts including David Sneddon, head of technical-analysis research at Credit Suisse Group AG in London, wrote in a note to clients.

Spain is likely to lose market access in the near term and will probably ask for precautionary sovereign bailout memorandum of understanding “within days,” Harvinder Sian, a senior rates strategist at Royal Bank of Scotland Group Plc in London, wrote in a research note today.

German Bunds

Germany’s 10-year yield climbed two basis points to 1.26 percent. It declined to 1.127 percent two days ago, matching the record low set on June 1.

Bunds stayed lower even after the Ifo institute in Munich said its business climate index dropped to 103.3 from 105.2 in June. That’s the lowest reading since March 2010. Economists predicted a decline to 104.5, according to a Bloomberg survey.

The Ifo data “suggest further weakness ahead,” Gustavo Bagattini, a European economist a Royal Bank of Canada, wrote in a note to clients. “The slowdown at the core of the euro-area economic engine will provide scope for the ECB Governing Council to ease monetary policy further.”

Bunds fell yesterday after Moody’s Investors Service cut the outlook on the nation’s top Aaa rating, citing concern it will have to support weaker euro-region members.

Debt Sale

Germany’s 30-year yield advanced two basis points to 2.17 percent. Today’s sale drew an average yield of 2.17 percent, the Bundesbank said. The nation received bids for 3.37 billion euros of the securities. The government also auctioned 752 million euros of inflation-linked debt maturing in April 2023.

The two-year note yield was at minus 0.061 percent, below zero for a 14th day.

German debt returned 4.1 percent this year through yesterday, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Spanish securities lost 9.6 percent, while Italy’s rose 3.9 percent.

Volatility on Spanish bonds was the highest in euro-area markets today, followed by Ireland and Portugal, according to measures of 10-year or similar-maturity debt, the spread between two-year and 10-year securities and credit-default swaps.

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