Europe to keep liquidity taps open

Frankfurt : The European Central Bank delayed its withdrawal of emergency liquidity measures and bought more government bonds as President Jean-Claude Trichet pledged to fight "acute" financial market tensions.

The Frankfurt-based ECB will offer banks unlimited loans through the first quarter over periods of seven days, one month and three months, Trichet told reporters at a press conference in Frankfurt. Irish and Portuguese bonds surged as ECB officials embarked on a new round of debt purchases, according to traders with knowledge of the transactions.

The ECB met under pressure from investors to stop the debt turmoil from engulfing Spain after the Irish rescue four days ago failed to persuade markets that policymakers have the resolve needed to contain it.

While Trichet signalled that the bond purchase programme was "ongoing," he also said there's a "clear need" for governments to fix their budget deficits.

"Uncertainty is elevated," Trichet told reporters after the ECB's Governing Council left its benchmark interest rate at 1 per cent yesterday. "We have tensions and we have to take them into account"

The euro traded at $1.3154 at 3:57pm in Frankfurt, around its level before Trichet started speaking. The yield on Portugal's 10-year government bond plunged 32 basis points to 6.63 points and the yield on Ireland's benchmark bond declined 27 basis points to 8.86 points. Spain's yield fell 18 basis points to 5.11 per cent.

Trichet's comments mark a shift from his stance last month, when he said that the ECB could start limiting access to its funds. The euro erased its advance and stocks turned lower.

Signalling disagreement within the 22-member council, Trichet said an "overwhelming majority" of officials backed the ECB's Securities Market Programme and that a "consensus" supported maintaining the status quo on providing liquidity. Bond purchases will continue to be offset to keep the money supply unchanged, in contrast to the Federal Reserve and the Bank of England, he said.

"It's not quantitative easing, we're withdrawing all the liquidity," he said.

Meaningful size

Some strategists said the ECB's refusal to follow the Fed and the Bank of England may soon end the rebound in bonds.

"The compression in spreads could prove temporary as Trichet has stressed that SMP is not QE," said Matteo Regesta, a fixed-income strategist at BNP Paribas SA in London. "In the scenario where SMP eventually increases to a meaningful size, weekly full sterilisation of the stock will become a non-trivial task. The only way to avoid such jam is to keep the programme at a low scale on average."

The U-turn on providing liquidity was not Trichet's first after he initially resisted demands to temper the Greek budget crisis earlier this year only to tear up the ECB's rule book in May by buying bonds in a decision which also split the council.

Spain

Calls for more integration

Spain insisted yesterday it will not need to tap a rescue fund but Prime Minister Jose Luis Rodriguez Zapatero said the time has come for the Eurozone to move towards a more integrated fiscal and economic policy.

Spain is quickly moving into the eye of the storm in Europe's debt crisis and its cost of borrowing at a three-year bond tender yesterday was around 50 per cent higher compared to the beginning of October.

But the jump was not as bad as feared and demand was solid, reflecting expectations the European Central Bank will prop up markets with more bond buying and the belief of some players that Spain is not as much at risk as recent market action suggests.

— Reuters