Spain and Italy smile as QE talk eases borrowing costs

ECB president Mario Draghi is fighting an increasingly desperate battle against deflation in the single currency bloc

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Fever-pitch speculation over a full-scale money-printing operation in the eurozone to shore up growth pushed the borrowing costs of Spain and Italy to all-time lows today.

The European Central Bank is so far the only major central bank to have shied away from launching quantitative easing – buying up sovereign debt – to lower interest rates and encourage growth.

But ECB president Mario Draghi is fighting an increasingly desperate battle against deflation in the single currency bloc and stepped up expectations in a recent speech when he said the central bank “will do what we must to raise inflation and inflation expectations as fast as possible”. Inflation stands at just 0.4 per cent – well below the ECB’s target of close to 2 per cent – and could drop to 0.3 per cent when estimates for November are published on Thursday.

Mr Draghi’s explicit statement that sovereign bonds could be bought in “unconventional” monetary policy sent dealers ploughing into Spanish and Italian government bonds. The buying spree drove yields on Spanish benchmark 10-year bonds – which move inversely to prices – below the 2 per cent mark for the first time. Italy’s benchmark cost of borrowing also hit an all-time low of 2.17 per cent as traders moved in ahead of anticipated ECB buying. One dealer said Mr Draghi could move as soon as the next ECB meeting on December 4.

Spanish yields hit 7.5 per cent in 2012, while Italy’s rose above 7 per cent in the worst phase of the crisis. Nick Spiro, of Spiro Sovereign Strategy, labelled the market rush the “Draghi effect”. He said: “When Spain’s yields drop below 2 per cent, but unemployment is 25 per cent and there’s been one of the dramatic deteriorations in the public finances across the eurozone, then something is clearly wrong.

“The expectation is that the ECB will act next month or in the first quarter of next year, but this should have happened two or three years ago.”

The eurozone just evaded a slide back into recession between July and September – inching forward 0.2 per cent – but the inflation picture remains desperately weak. Mr Draghi has cut deposit rates for banks into negative territory, launched a Funding for Lending style scheme and begun buying covered bonds – bundles of private sector loans – to boost credit conditions, but would still face opposition to full-blown QE from the Germans.

Bundesbank president Jens Weidmann said yesterday there were “high legal hurdles” for QE due to the bar on monetary financing set in the ECB’s treaty. Other policymakers including ECB vice-president Vitor Constancio and Austria’s central bank chief Ewald Nowotny are in the “wait and see” camp to judge the effect of previous measures.