ECB pledge gets Spain, Italy rates down

[August 08, 2011]  BRUSSELS (AP) -- The European Central Bank's decision to buy billions of euros worth of Spanish and Italian bonds pushed down the two countries' borrowing costs Monday, but analysts warned that the move transfers significant risks onto the balance sheets of an institution long reluctant to move beyond its traditional role controlling inflation.

The radical expansion of the ECB's bond-buying program cements the bank's role as the institution with primary responsibility for solving's Europe 21-month-old financial crisis.

The ECB has been reluctant to become directly involved in averting the crisis, instead pushing politicians to get their countries' finances under control and build up their own crisis management system.

But a recent spike in investor concern about Italy and Spain's high debt levels and lackluster economic growth caught the 17-country eurozone just as parliaments broke up for the summer recess, delaying the implementation of crucial changes to the currency union's bailout fund.

Those changes, once implemented, would allow the European Financial Stability Facility to buy government bonds on the open markets, just as the ECB has done.

The French parliament won't be able to approve the expansion of the European bailout fund before September, France's finance minister said.

French legislators are scheduled to hold a special session Sept. 6 to vote on a budget amendment allowing funding for the new aid plan approved by EU leaders July 21. Asked whether parliament could be convened immediately instead, Francois Baroin said on Europe-1 radio that: "For a democratic process with such heavy stakes, we cannot go any faster."

With similar votes on hold across the EU, the ECB decided late Sunday decided to "actively implement" its bond-buying program, one of its main crisis tools that it had so far not used for Italy and Spain.

The central bank is now expected to buy an average of 2.5 billion euros worth of Spanish and Italian bonds each day, equivalent to 600 billion euros a year, analysts at the Royal Bank of Scotland wrote in a note.

Buying bonds supports their prices, taking pressure off the issuing countries during an investor sell-off. In early trading Monday, the yield, or interest rate, on Italy's 10-year bonds was down 0.55 percentage point to 5.45 percent while the equivalent rate on Spain's tumbled 0.71 percentage point to 5.34 percent.

The ECB program could quickly push down the interest rate spread between the two countries' bonds and those of Germany -- seen as the eurozone's safest sovereign -- by 1 to 1.5 percentage points, RBS said.

Italy's and Spain's borrowing costs rose to above 6 percent last week -- rates that are deemed unsustainable in the long-term for the eurozone's third and fourth largest economies.

But the program will likely take its toll on the interest rate paid by rich nations such as Germany when they borrow in the markets. The ECB's move will not only slow a recent flight to safety that has kept German interest rates very low, but also transfers credit risk from the Italian and Spanish governments to the central bank, and ultimately eurozone taxpayers.

Until now, the ECB had invested just under euro80 billion ($113 billion) in Greek, Irish and Portuguese bonds.

That appeared to cushion the feared fallout from Standard & Poor's decision last Friday to downgrade U.S. long-term debt.

In contrast to the bond-buying programs of the U.S. Federal Reserve and the Bank of England, the ECB "sterilizes" its bond purchases by withdrawing funds from the financial system so that the overall amount of money in circulation remains the same and inflation doesn't shoot up.

The ECB's decision to take a more active role came after both Italy and Spain announced new measures to cut spending and boost growth. Italian Prime Minister Silvio Berlusconi Friday night said that his country would work to balance its budget by 2013, a year earlier than planned.

Spanish Finance Minister Elena Salgado on Sunday announced new reforms aimed at bringing in an extra euro5 billion to help achieve its goal of cutting its deficit to 6 percent of GDP this year.

She said half the money will come from changing a staggered corporate tax payment system so that large companies have to pay earlier in the year, although actual tax rates will not go up.

The other half of the euro5 billion will come from savings in state-run hospital spending via purchases of generic medicines, Salgado told the news agency Efe in an interview. These changes will be approved at a Cabinet meeting either August 19 or 26.

[Associated Press; By GABRIELE STEINHAUSER]

Pan Pylas in London, Greg Keller in Paris, Daniel Woolls in Madrid, David McHugh in Frankfurt, Germany, contributed to this article.

Copyright 2011 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.