ECB FOCUS-EU delay won’t force ECB back to bond markets

* ECB determined to normalise monetary policy

* Only major, widespread market turmoil would force its hand

* Contagion risks of inaction seem to have decreased

* Some see ECB repairing its credibility

By Sakari Suoninen

FRANKFURT, March 25 (Reuters) – The European Central Bank is
likely to stay out of the bond market despite political turmoil
in Portugal and governments’ failure this week to finalise steps
to address the euro zone debt crisis.

The ECB, which began buying indebted governments’ bonds from
the market last year as an extraordinary step to cope with the
crisis, might be expected to resume buying now as Portuguese
yields shoot up to historic highs.

But the ECB seems determined to withdraw from its role as
the euro zone’s last line of financial defence, and to return to
its core role of curbing inflation. So market instability would
probably have to be much more severe and widespread to persuade
the central bank to buy bonds actively.

The latest official data shows the ECB did not buy any bonds
in the week to March 18, extending a pause in its purchasing to
three weeks.

Last year, in the run-up to Ireland’s international bailout,
the ECB sharply cut back its bond purchases; analysts saw this
as designed to pressure European governments into taking more
aggressive steps to address the regional debt crisis.

The central bank now appears to be adopting the same
strategy, using its inaction in the bond market to pressure
Lisbon and other governments to agree on a bailout of Portugal,
and to persuade governments to finalise their crisis package.

“The message is very clear to policymakers in Europe — take
responsibility, we’ve done our part, we will concentrate on
monetary policy now,” Nomura economist Laurent Bilke said.


For a graph of ECB bond purchases click:

For a package of graphics on the euro zone crisis click:


The 10-year Portuguese government bond yield (PT10YT=TWEB: Quote, Profile, Research)
has been rising rapidly since Portugal’s government collapsed on
Wednesday, raising the possibility that a lame duck caretaker
government will hold power for two months until an election can
be called. The yield, already at levels which analysts believe
Portugal cannot afford over the long term, climbed above 8.0
percent on Friday.

Meanwhile a summit of European Union leaders in Brussels,
which had been intended to finalise a “comprehensive package” of
steps to handle the regional debt crisis, failed to do so
because of looming elections in some countries and continued
bickering over details. The leaders gave themselves until June
to agree on how to expand the euro zone’s bailout facility.

This could put more pressure on the ECB to stabilise bond
markets until the bailout facility has been expanded. But
traders have not noticed any bond buying by the central bank in
the last few days, and it seems to be resolved to kick the ball
back to the EU.

“There was a point in time when we thought that they would
intervene to stop 10-year yields from going above the 7 percent
level,” said Andrew Bosomworth, a senior portfolio manager at
Pimco in Munich.

“It appears now that their behaviour is to focus on
smoothing volatility…which I think is consistent with their
desire to extricate themselves from the fiscal role.”

One reason that the ECB believes it can get away with not
intervening, analysts believe, is that in contrast to Greece’s
crisis last year, the problems of individual euro zone states no
longer seem to pose much threat to the stability of the zone as
a whole. The euro (EUR=: Quote, Profile, Research) has dropped only slightly this week.


While Portugal remains shaky and before the EU finalises its
crisis package, the ECB is unlikely to be able to formally
declare the closure of its bond buying progarmme.

ECB Governing Council member Ewald Nowotny said on Thursday
that the central bank would withdraw its emergency measures as
soon as possible, but that he was increasingly pessimistic about
the chances of it doing so.

“Three weeks ago I was more confident than today that this
could happen,” Nowotny said. “But we have to use every chance to
move from crisis mode to normal monetary policy instruments.”

However, there would now have to be a much larger threat of
the crisis spreading through the euro zone — for example, a
renewed rise of Spanish bond yields — for the ECB to resume
large-scale purchases, many analysts believe.

“There would need to be risks that the financial system
could be severely damaged,” Citibank economist Juergen Michels

By not blinking in the face of Portugal’s debt problem, the
ECB may benefit from a stronger reputation for independence.
Some ECB policymakers feel the 12-year-old central bank damaged
its inflation-fighting credibility by agreeing last year to the
bond-buying scheme; its stance now may help to repair that

“If the ECB resists buying these bonds now, it will have
grown up more quickly than the Bundesbank,” said Geoffrey Wood,
economics professor at Cass Business School in London.

“If it doesn’t buy bonds now, under great political pressure
no doubt, it will be coming of age.”

(Additional reporting by Paul Carrel and Marc Jones; Editing by
Andrew Torchia)

ECB FOCUS-EU delay won’t force ECB back to bond markets