June 20, 2012 / 1:46 PM / 5 years ago

Bond-buying by EU rescue funds unlikely and maybe unwise

* Brussels denies plan for bailout funds to buy bonds

* Italy’s Monti floated idea at G20

* Scheme would come with unpalatable strings attached

* Bond-buying would diminish size of euro zone firewall

By Lisa Jucca and Sakari Suoninen

MILAN/FRANKFURT June 20 (Reuters) - A call for euro zone bailout funds to buy government debt of countries like Spain and Italy is a long way from being heeded and even if it was, is unlikely to win over investors unless the European Central Bank also steps in decisively.

At a G20 summit in Mexico on Tuesday, Italian Prime Minister Mario Monti proposed the bloc’s two rescue funds intervene to help his country service its sovereign debt.

French President Francois Hollande voiced his support and said the pair would discuss it with Germany’s Angela Merkel and Spain’s Mariano Rajoy at a mini-summit in Rome on Friday.

EU paymaster Germany appears disinclined to support it and observers are sceptical that using limited euro zone funds to prevent an Italian or Spanish default would work.

“That proposal reminds me of two Friday-night drunkards leaning against each other,” said Burkhard Varnholt, Chief Investment Officer of Swiss wealth manager Bank Sarasin.

Moreover, any cash injection would come with strings attached in the form of fiscal and structural commitments, equivalent to the sort of bailout programmes that Italy and Spain are trying to avoid because of the stigma attached.

“There was no discussion here in Los Cabos about any concrete initiatives related to such purchases,” a German government official told Reuters, speaking on condition of anonymity.


The EU Commission said on Wednesday there was no plan to relieve tension in the Italian and Spanish bonds market by using bailout funds. EU spokesman Amadeu Altafaj said any mechanism aimed at keeping a keeping bond yields in check would be a sort of ‘financial paracetamol’ unable to calm markets.

Economists also gave it a lukewarm reception.

“It is rather disappointing that such a limited and unimaginative step should be tabled at this stage, the crisis demands a more profound response,” JP Morgan senior economist Malcolm Barr said, urging the ECB to play a part.

“Attempts to ‘correct’ high sovereign debt yields by interventions appear unlikely to succeed beyond very short term effects unless they are conducted on an overwhelming scale.”

Italy’s debt is approaching 2 trillion euros ($2.54 trillion), including 300 billion euros of postal debt, while Spain’s is around 775 billion euros.

The existing EFSF rescue fund only has around 240 billion euros remaining while the European Stability Mechanism (ESM) will come onstream next month and eventually have 500 billion at its disposal.

The experience of the ECB’s bond-buying programme last year, which it is extremely reluctant to revive, showed it had to spend up to 14 billion euros a week when it rode to Italy’s rescue.

And even then, the effect was ephemeral.

“The programme has had very limited success,” ABN Amro economist Nick Kounis said. “It’s difficult to argue with facts, the impact on bond yields has been rather fleeting.”


Spending at that pace would quickly erode the bailout funds which may yet have to be called on for a Spanish sovereign bailout which could cost up to 700 billion euros, leaving the euro zone again looking short of defences.

The funds could be used to indirectly prop up Italian and Spanish government bond sales at auctions and potentially keep a lid on the high interest rates they are now forced to offer investors. But they would do little to stem the tide of foreign investors’ sales on the secondary market.

Foreigners used to hold around 700 billion euros of Italian bonds, but that amount is estimated to have fallen by 140 billion euros in less than a year.

“I think it would be a helpful supplement to the arsenal of firewalls, assuming the ESM has the proper governance for it, but it won’t reduce the need for a banking union,” said Erik Nielsen, chief economist at UniCredit.

Policymakers hope an end-June EU summit can agree on concrete steps to tackle the crisis, such as forging a banking union able to underwrite euro zone bank deposits.

Yet creating such an ambitious architecture would require several months, if not years, under complex EU governing rules, far too long for impatient hedge funds and other investors.

Another problem was thrown into sharp relief by the negative market reaction to a euro zone offer of up to 100 billion euros to bail out Spain’s banks.

Because the money may come from the ESM and it has preferred creditor status, private investors feared they would be last to get paid back in the event of a default.

The same problem applies to the ECB’s bond-buying programme. Having not taken a writedown as part of Greece’s second bailout, bond investors also see the central bank as being above them in the creditor pecking order. If the ECB came in, it could drive private investors out.

What could work is for the ESM to be granted a banking licence so it can draw on ECB funds.

“That would be QE via back door, effectively the ESM would use unlimited ECB money to buy bonds,” Kounis said: “I think it would be effective, as it would have unlimited firepower.”

But Germany and the ECB are firmly opposed to that.

“The only nuclear weapon the euro zone has is to have the ECB intervene with its own balance sheet, that is by buying government bonds directly,” said Luca Mezzomo, head of macro research at Intesa Sanpaolo.

But internal opposition is stiff. “The Bundesbank’s critical stance on the bond purchases is known,” German central bank chief Jens Weidmann said on Wednesday.

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