Italy Borrowing Rates Drop Again In Bond Auction

Published January 13, 2012 3:18PM (EST)

ROME (AP) — Investors applauded new fiscal policies in some of Europe's most troubled economies in a week of surprisingly positive signs for the continent's debt crisis, including the second successful Italian bond auction in as many days. But Greece struggles to negotiate with private lenders amid investor fear that Europe's credit rating could be under attack.

Italy successfully sold about euro4.75bn ($6.05 billion) of bonds on Friday, capping a strong week for government debt auctions that saw its borrowing costs drop for a second day in a row.

The auction caps a rare week of good news for Europe's financial system. On Thursday Spain and Italy completed successful bond auctions. Meanwhile, European Central Bank president Mario Draghi noted "tentative signs of stabilization" in the region's economy and said the ECB had prevented a serious credit contraction in the eurozone with a massive injection of cheap funds in December.

However, investors and markets recognize that, while some progress has been made this week, a long haul to full economic recovery lies ahead. Markets across Europe fell in afternoon trading Friday on reports that rating agency Standard & Poor's was poised to downgrade the debt of several countries in the eurozone and talks in Athens between the Greek government and private investors failed to reach agreement on a crucial debt swap and are set to pick up gain next week.

Investors demanded an interest rate of 4.83 percent to lend Italy three-year money, down from an average rate of 5.62 percent in the previous auction and far lower than the 7.89 percent in November, when the country's financial crisis was most acute.

While Italy paid a slightly higher rate for bonds maturing in 2018 which were also sold in Friday's auction, demand was between 1.2 percent and 2.2 percent higher than what was on offer.

The results were not as strong as those of bond auctions the previous day, when Italy raised euro12 billion ($15 billion) and Spain saw huge demand for its own debt sale.

"Overall, it underscores that while all the auctions in the eurozone have been battle victories, the war is a long way from being resolved (either way)," said Marc Ostwald, strategist at Monument Securities. "These euro area auctions will continue to present themselves as market risk events for a very protracted period."

Italy's euro1.9 trillion ($2.42 trillion) in government debt and heavy borrowing needs this year have made it a focal point of the European debt crisis. Fitch Ratings Agency, which has said it would consider whether to downgrade Italy's credit rating by the end of the month, estimates the country needs to borrow euro360 billion ($458 billion) this year.

Italy has passed austerity measures and is on a structural reform course that Premier Mario Monti claims should bring down Italy's high bond yields, which he says are no longer warranted.

Analysts have said the successful recent bond auctions were at least in part the work of the ECB, which has inundated banks with cheap loans, giving them ready cash that at least some appear to be using to buy higher-yielding short-term government bonds.

Some 523 banks took euro489 billion in credit for up to three years at a current interest cost of 1 percent.

Banks may also be buying up government bonds to use as collateral so they can tap another unlimited offering of three-year ECB credit to banks that is to be handed out on Feb. 29.

That factor could fade after the February credit allotment, however, said Rabobank analyst Jane Foley.

But use of the 3-year ECB loan money could mean that "the implications are more positive for the periphery and successful peripheral debt issuance is likely to last longer," she said.

Peter Schaffrik, head of European rates strategy for RBC Capital Markets, said the ECB had helped scale back fears prevalent late last year of an imminent European financial collapse.

"A good deal of credit should be assigned to the ECB, which has been, and will be, we argue, supporting the European financial system, its sovereigns, and to some degrees the European economies via significant liquidity injections and lower rates," Schaffrik wrote in a note to investors.


David McHugh in Frankfurt contributed.

By Salon Staff

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