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Lower ECB debt purchases ease euro debasement fears

The European Central Bank spent just EUR4.5 billion in the bond markets in the week to November 9 as it attempted to stop Italian borrowing costs from spiralling out of control, official data revealed on Monday.

That was less than half the intervention in the previous week, and well below market expectations.


   Silvio Berlusconi

The action came as BTP yields hit a euro-era high of 7.48% last Wednesday, a development which undermined confidence that Italy could service its massive $2 trillion in sovereign debt and triggered the resignation of Italian prime minister Silvio Berlusconi and a sell-off in the euro. News of the relatively small size of the intervention eased tensions over the role of the ECB amid the ongoing turmoil on European sovereign debt markets.

It lessened fears that the central bank could be veering down a path of debt monetisation which might undermine its inflation fighting credentials and weigh on the euro.

Traders warned those worries could grow, however, given that the data did not include what was believed to be even heavier intervention from the ECB since November 9. It is believed that the central bank raised its intervention efforts after Berlusconi announced his intention to depart last Thursday, a reflection that the ECB was more more confident that his removal would speed up Italian fiscal reforms.   

Germany’s central bank raised concerns over the ECB becoming the lender of last resort to debt stricken eurozone nations on Monday.

Jen Weidman, president of the Bundesbank, called for international pressure for the ECB to play a bigger role in tackling the eurozone debt crisis to end as it could undermine the central bank’s inflation fighting credibility.

He warned that the ECB should not be used to finance governments or prop up insolvent banks.

"The participation of monetary policy for fiscal policy purposes must come to an end," said Weidman.

"Should monetary policy further stretch its mandate to deliver price stability or even violate forbidden rules of fiscal financing, nothing less is at stake than its credibility, which it has worked hard to gain over decades."

The call echoed the views of the ECB’s new president Mario Draghi, who said at his inaugural press conference earlier in the month that the central bank should not act as lender of last resort.

The problem, however, is that eurozone authorities have little option but to rely on the ECB in order to prop up the region’s government bond markets.

That is because the European Financial Stability Facility, the eurozone’s rescue fund, does not have the firepower to bail-out a country the size of Italy.

Indeed, ratings agency Moody’s warned on Monday that in light of the contagion in eurozone debt, the EFSF could not meaningfully support the region’s large government bond markets.

“This limits the EFSF’s role as an important pillar of the eurozone crisis management strategy,” Moody’s said.

John Normand , head of global FX strategy at JPMorgan, said by now almost everybody outside of the ECB and the German government contended that massive debt monetisation would be required to manage Europe’s sovereign funding crisis, with most arguing that it would be hugely negative for the euro.

Normand argued that at this stage in the inflation and global interest rate cycle, it was not clear that large scale asset purchases would be so destructive for the single currency.

“If quantitative easing undermines currencies through higher inflation or inflation expectations, the 2012 recession is a much more auspicious time for debt monetisation currency-wise than the Fed and Bank of England’s first attempts at QE in 2009,” he said.

“Over EUR300biullion of additional debt monetization could be consistent with euro stability.”

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