New ECB Bond Purchase: Will It Offset S&P US Debt Downgrade?

The European Central Bank will begin to buy the sovereign bonds of Spain and Italy as a way to provide the two countries time to get their houses in order and to shore them up against a bond market which tends to short weak obligations. The decision comes on the same weekend as the Standard & Poor’s downgrade of US debt. This creates a classic battle of which news will most affect the equities markets as they open.

The Governing Council of the European Central Bank (ECB) welcomes the announcements made by the governments of Italy and Spain concerning new measures and reforms in the areas of fiscal and structural policies.

The central bank added:

It is on the basis of the above assessments that the ECB will actively implement its Securities Markets Programme. This programme has been designed to help restoring a better transmission of our monetary policy decisions – taking account of dysfunctional market segments – and therefore to ensure price stability in the euro area.

The ECB has no intention of allowing the fiscal damage in Greece, Ireland, and Portugal to spread to the more viable nations of Spain and Italy. The ECB also know that the powers of the EU–Germany and France–are unlikely to join a bailout of Spain or Italy which would cost in the hundreds of billions of dollars, even with the support of the IMF.

The debt problems in Europe has been “solved” several times now. Greece has received two bailouts. Portugal and Ireland one each. All nations involved have agreed to severe austerity measures. The global capital markets have not been convinced. Borrowing costs for Spain and Italy continue to rise. The ECB means to stop that.

On the other side of the Atlantic there is uncertainty about what the S&P downgrade will mean. Some experts say it was expected. The US will have no trouble raising money at current rates, they say. Other economists believe investors will move money out of US paper. The Treasury’s cost to borrow will rise, and with it interest rates on everything from car loans to the debt service of large corporations.

As the markets open, there will be one and not two things to consider, neither of them set in place just three days ago.

Douglas A. McIntyre