ECB fixes to load up on bonds

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The European Central bank will open a new assault on the debt crisis with a plan to buy unlimited amounts of the sovereign bonds of distressed countries, an aggressive move that appears to be aimed at sparing Spain from outright collapse.

The ECB, led by president Mario Draghi, is to unveil the bond-purchase program in Frankfurt on Thursday after months of relentless pressure from Spain and Italy, whose financial failures could rip the euro zone apart, to intervene on their behalf. The Bundesbank, Germany's central bank, has opposed the bond purchase plan, arguing it would push the ECB astray from its central role as an inflation fighter.

According to various reports and clues from Mr. Draghi himself, the ECB will buy only short-dated paper – bonds with maturities of three years or less – and will not put a cap on yields, implying unlimited purchases. Any purchases would be "sterilized," meaning that equivalent amounts of money would be removed elsewhere from the euro zone economy to prevent a sudden surge in money supply from triggering inflation.

Any ECB bond purchases would come with strict conditions. A country in distress would first have to apply to either or both of Europe's rescue funds for emergency assistance. The funds would buy long-term bonds. Only after that would the ECB buy short-term bonds.

On Wednesday, economists said the unlimited purchases are an improvement on the ECB's previous bond-buying program, whose conditions were largely ignored by Italy a year ago, when Silvio Berlusconi was prime minister, and which was limited in size. The effort brought down yields of Italian and Spanish debt only temporarily.

Economist Peter Vanden Houte, of ING Groep's Financial Markets division, said "the threat of unlimited intervention implies that the ECB might have to intervene less this time round. However, everything hinges on the perceived credibility of the promise."

He added that the ECB's new program, while improved over the previous (and now defunct) bond-purchase effort, does not appear to be a "game changer" since it is essentially a variation on an old theme.

The currency markets were buoyed by prospect of unlimited bond purchases. The euro rose about 0.3 per cent, to $1.26 (U.S.).

Italy and Spain, the euro zone's third- and fourth-largest economies, have been lobbying hard for months for ECB bond purchases as their borrowing costs rise and their economies contract.

While Italy's recession is deeper than Spain's, Spanish borrowing costs are higher, its banks are in far deeper trouble and its jobless rate, at about 25 per cent, is the highest in Europe.

Spain, unlike Italy, is also victim to a capital exodus that is accelerating its banking and economic problems.

A note published Tuesday by Nomura strategists Jens Nordvig and Charles St-Arnaud, in New York, tallied the data to reveal what they called an "extreme" capital flight. "While both countries are experiencing outflows, the sheer size of the Spanish outflows is worrisome," the wrote.

Foreigners are dumping Spanish securities and liquidating their banking claims in Spain. Spanish residents are yanking their bank deposits and stashing their loot in safe countries such as Germany and Britain.

Taken together, the net outflow of private sector capital is massive, equivalent to about 50 per cent of Spanish gross domestic product at the end of the second quarter. That's more than three times greater than the Italian capital exodus.

"Our economics team believes that Spain will not be able to avoid a full-blown bailout," the Nomura note said. "The scale of the capital fight that took place over the last few months in Spain supports this view."