ECB eases debt woes but flight to safety continues


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Borrowing costs for Italy and Spain fell yesterday after the European Central Bank widened the scope of its intervention in the bond markets.

The move gave confidence to investors, who were asking for as little as 5.24 per cent interest to lend money to Rome for 10 years yesterday, and for as little as 5.1 per cent for Spain. Last week, the two countries were facing costs of more than 6 per cent, a level seen as unsustainable by analysts.

The ECB made its first move in the morning, according to traders, who said it appeared to have bought around €2bn in Italian and Spanish debt. There were also signs of a second round of intervention in the afternoon.

"Speculators will now have to think twice about selling or shorting Italian and Spanish bonds, knowing the ECB will be acting against them," said Shane Oliver, the head of investment strategy at the fund manager AMP Capital Investors.

Although the ECB broke its 18-week hiatus from the bond markets last week, it limited its action to Irish and Portuguese debt. The reluctance – attributed to a desire among monetary policymakers to see faster reforms in debt-ridden countries – triggered a sell-off around Italian and Spanish debt. Traders said that, until the EU's bailout fund had the authority to buy bonds, the ECB was the only body capable of soothing the markets.

But hopes of an intervention were raised after the Italian Prime Minister, Silvio Berlusconi, pledged to speed up reforms late on Friday. The action was confirmed in a statement from the ECB on Sunday night.

Despite the bank's action, however, investors remained nervous about the endgame for the EU debt crisis, the health of the global economy and the potential destabilising effect of the US losing its AAA credit rating.

Still, far from pushing interest rates higher, the Standard & Poor's (S&P) downgrade of US government debt did nothing to dampen investors' views that it remains one of the safest assets available in times of turmoil. Demand for Treasuries pushed prices higher, and therefore interest rates lower, with the yield on 10-year US Treasury debt falling below 2.4 per cent to its lowest rate since last autumn.

Traders remained wary of the knock-on consequences of the downgrade, though, as S&P moved to cut its rating on scores of other bonds. Fannie Mae and Freddie Mac, the two government-owned mortgage finance houses, who own or guarantee almost all the new residential mortgages being signed in the US, were cut from AAA to AA+. There were similar cuts to government-guaranteed debt issued by bailed-out banks in 2008.

The rating agency also cut a number of private-sector businesses. Bonds issued by five large life-insurance companies, whose portfolios are heavily weighted towards US Treasuries, were cut to AA+, as was the debt of the Depository Trust Co, National Securities Clearing, Fixed Income Clearing and the Options Clearing Corp, four clearing houses which process derivatives trades.