ECB support for Italy debt melts away

THE YIELD on Italy’s long-term debt shot to euro-era highs yesterday during its first long-dated bond auction since the sovereign was downgraded by ratings agencies.

Following the revelation that Italy’s deficit rose to 3.2 per cent of GDP in the second quarter, versus 2.5 per cent the year before, Rome paid a high of 5.86 per cent to offload the €7.86bn of notes, perilously close to the perceived “crisis” threshold of six per cent.

The yield spike fuelled speculation that the European Central Bank (ECB) is scaling down its support for the sovereign, which market participants have attributed to Rome’s haphazard approach to its deficit reduction.

The details of a letter from ECB president Jean-Claude Trichet to Italian Prime Minister Silvio Berlusconi emerged yesterday, showing that the Bank offered its support only in return for concerted action on Italy’s rising debt pile.

In the letter, published in an Italian newspaper, Trichet told Berlusconi: “The [ECB] governing council considers that pressing action by the Italian authorities is essential to restore the confidence of investors.”

Data out last week showed that the ECB’s intervention in European sovereign bond markets dropped from well over €10bn in previous weeks to just €4bn of purchases last week.

The Bank was believed to be targeting a ten-year yield of five per cent for Italy and Spain, the targets of its action, but yesterday’s price movement suggests that support has diminished.