Thursday, June 28, 2012

Reuters: US Dollar Report: UPDATE 1-EU leaders seen discussing primary market support for Italy, Spain

Reuters: US Dollar Report
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UPDATE 1-EU leaders seen discussing primary market support for Italy, Spain
Jun 28th 2012, 17:09

Thu Jun 28, 2012 1:09pm EDT

By Luke Baker and Jan Strupczewski

BRUSSELS, June 28 (Reuters) - European Union leaders are likely to discuss the possibility of the euro zone's bailout funds buying Spanish and Italian bonds as they are issued, to help ease funding costs for Rome and Madrid, EU officials said on Thursday.

The temporary European Financial Stability Facility (EFSF) and its replacement, the European Stability Mechanism (ESM), have a mandate to buy bonds of euro zone countries directly at the primary auction.

The bailout funds can also do that via a co-investment fund (CIF) with private investors. The euro zone vehicles would normally be first to take a potential loss that such a CIF could make on the purchase, should the sovereign default.

The two funds can also provide partial guarantees to government bonds sold at primary auctions, diminishing the risk for investors buying the paper.

Neither option has been used so far.

"We've got to look at existing instruments and both the EFSF and the ESM, once it is active, have the capacity to buy bonds in the primary market," one EU official said, as EU leaders gathered for their 20th summit since the debt crisis struck.

"That's the area that makes sense to operate on," the official said.

Italy's benchmark borrowing costs hit six-month highs at auction on Thursday, piling pressure on Prime Minister Mario Monti to ease a heavy debt burden by squeezing concessions out of Germany at a European summit.

The Treasury sold 5.42 billion euros in 10-year bonds, near the top of its lower-than-average target range, helped by domestic demand fed by large redemption flows.

But 10-year yields rose to 6.19 percent from 6.03 percent a month ago, in turn further fuelling concern on markets.

Spain's short-term borrowing costs nearly tripled at auction on Tuesday, underlining the country's precarious finances as it struggles against recession and juggles with a debt crisis among its newly downgraded banks.

The yield paid on a 3-month bill was 2.362 percent, up from just 0.846 percent a month ago. For six-month paper, it nearly doubled to 3.237 percent from 1.737 percent in May.

Spain has already asked its European Union partners for up to 100 billion euros in aid for its banks, but financial markets have not eased in their pressure, seeing much of the EU's efforts as only temporary solutions.

STIGMA OF REQUESTING AID

Neither Spain not Italy is keen to apply for a euro zone financing programme because of the political stigma attached to it, the conditions imposed and the intrusive monitoring from euro zone institutions of whether the conditions are met.

Details of what conditions countries such as Spain and Italy would have to meet in return for a potential primary market intervention programme still needed to be discussed, the official said.

EFSF guidelines on primary market purchases of bonds say it can be done as an addition to either a normal loan programme or to a precautionary credit line granted to the country.

The guidelines also specify that the euro zone bailout funds cannot buy more than 50 percent of the issue at the auction and should do so at the weighted average price to minimize the impact on the result.

According to the guidelines such primary market intervention would normally take place only if "a reasonable participation of private investors at a rate not excessively above the EFSF funding rate as the Reference Funding Rate is possible".

"The analysis whether a rate is excessive should be based on an assessment of the financing needs and gap of a country in the context of the overall monitoring, as well as an assessment of current market conditions," the guidelines say.

The Eurogroup Working Group of deputy finance ministers and treasury officials met at 1500 GMT on Thursday to discuss ways of lowering the dangerously high financing costs for Spain and Italy with existing instruments, one euro zone official said.

According to existing rules, Madrid and Rome would need to request primary market assistance from the euro zone and agree to some conditions in a memorandum of understanding to get it.

Another EU official said the conditionality could be light, asking for no more than the European Commission's country specific recommendations for EU members, approved by EU finance ministers last week, on structural reforms and lower deficits.

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