The European Central Bank needs to back up last week's record purchases of government debt with further buying to prevent speculators from driving borrowing costs for Spain and Italy back up again.
"The ECB's bond purchase programme has been a very effective deterrent to panic selling, and as long as they don't blink now, they can have this problem of speculative shorting licked in weeks rather than months," said Luca Jellinek, the London-based head of European rate strategy at Credit Agricole Corporate & Investment Bank.
The ECB snapped a five-month hiatus to buy €22 billion (Dh116 billion) of government bonds in the week through August 12, and has bought more securities since. That helped push ten-year Spanish and Italian yields below 5 per cent after they surged to euro-era records the previous week amid concern contagion from the debt crisis had infected both countries.
The success mirrors the initial benefit of the ECB's first programme of buying Greek bonds in May 2010. Policymakers must avoid what came after that: a reluctance to extend the programme with further purchases saw Greek ten-year yields reverse declines and soar by more than 10 percentage points.
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Staying in play
"They don't need to do massive amounts every week, but they do need to remain in the market to help stabilise the situation," said Olaf Penninga, who helps manage €140 billion at Robeco Group in Rotterdam.
"They could probably get away with a few billion a week if asset markets remain relatively stable, but they would have to do considerably more if political tensions arise, like internal disagreement within the ECB or opposition to the buying from Germany."
Ten-year Greek yields initially dropped as much as 468 basis points after the central bank began €16.5 billion of Greek bond purchases last year. Some 14 months later, the yield had soared as high as 18.39 per cent.
The ECB has overcome internal opposition among its board members to more bond purchases as bond market moves suggested the region's debt crisis was spreading to economies considered too big to rescue by investors.
Italy has the Eurozone's largest outstanding debts at €2.1 trillion, including principal and interest payments, according to Bloomberg data. That compares with €838 billion for Spain, the fourth-biggest burden in the region.
Italy's ten-year borrowing cost was at 4.90 per cent after surging to a euro-era record 6.40 per cent on August 5.
Similar-maturity Spanish debt yields 4.91 per cent, after touching 6.46 per cent on August 2, the most since the introduction of the shared currency in 1999.
European leaders are struggling to find a solution to the debt crisis, after a July 21 accord to bolster the region's rescue fund failed to calm markets. German Chancellor Angela Merkel and French President Nicolas Sarkozy rejected an expansion of the €440 billion rescue fund on Tuesday and rebuffed calls for a common Eurozone bond, saying greater economic integration was needed first.
The two largest Eurozone economies will instead push for tougher fiscal debt limits and the establishment of a "euro council" as part of a planned "economic government" for the region, Sarkozy said after the two-hour on Tuesday meeting with Merkel in Paris. Germany and France still share an "absolute determination" to defend the euro, said Sarkozy.
Dutch Finance Minister Jan Kees de Jager backed the opposition to a common euro-area bond, telling his nation's parliament that while jointly issued debt was interesting "conceptually," it would not solve the region's debt woes.
"In the absence of a sustainable policy solution, ECB buying is the only viable stopgap," said Padhraic Garvey, the head of developed-debt market strategy at ING Groep NV in Amsterdam. "The ECB does not know it yet, but it will find that it cannot step away from its bond buying."
Purchases may need to be as big as "something approaching forthcoming supply," according to Credit Agricole's Jellinek.
Italy needs to refinance an average of about €7.5 billion per week in maturing principal and interest payments for the remainder of this year, according to calculations by Bloomberg News. That's more than double the weekly average of €3.4 billion for Spain.