Markets volatile after ECB move

8 August 2011 Last updated at 06:06 ET

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European stock markets have given up early gains, which had been triggered by the European Central Bank saying it intended to buy up government debt.

Spanish and Italian markets jumped in early trading before slipping back, while major European indexes slid sharply in mid-morning trading.

In London the FTSE 100 index lost 1.5%, while Frankfurt’s Dax was down 2.5%.

However, yields on Spanish and Italian government bonds fell significantly after the ECB’s intervention.

The yield on Spanish 10-year bonds – an indication of the risk associated with lending Spain money – fell from more than 6% to about 5.2%. Yields on Italian bonds fell by a similar amount.

Earlier, Asian shares fell as investors worried about rating agency Standard and Poor’s downgrade of US debt.

Japan’s Nikkei and South Korea’s Kospi indexes lost 2.2%, while Hong Kong’s Hang Seng dropped 3.8%.

Fears that European markets would follow suit appeared unfounded as the Spanish and Italian markets both rose by more than 2% as traders reported that the ECB had started buying government bonds from both countries.

However, the feel-good factor did not last long, with major European stock exchanges all slipping back by mid-morning.

Last week saw trillions of dollars wiped from the value of global markets, with the Dax losing about 13% of its value, the FTSE 100 dropping 10% and the Dow ending the week 5.8% lower.

More wobbles?

Analysts warned that markets would remain volatile in coming weeks, despite the G7 group of developed countries and the ECB vowing to support financial stability.

On Sunday, the ECB indicated that it would start buying the bonds of eurozone governments, hoping to instil confidence that some of its biggest economies would not default on their debt obligations.

Bonds are essentially IOUs issued by governments, or companies, to raise cash. Governments issue new bonds to help pay maturing bonds, which is why it is so important that investors continue to buy them – if they don’t, governments are unable to pay their outstanding debts.

Analysts were mixed in their reaction to the ECB’s move, and said the markets would be hoping to see more action in Europe.

“Clearly, the S&P downgrade is a very symbolic and historic event,” said Paul Sheard of Nomura. “But really the epicentre of this crisis, unlike 2008, is very much in the eurozone.”

“So I think the markets will be focusing very much on what the euro area policymakers will do over the coming weeks.”

In a separate statement, the G7 group of developed countries said members were “determined to react in a co-ordinated manner” to preserve financial stability.

The intervention by the ECB is seen as a short-term measure to help calm stock markets, but what investors want to see most of all is highly-indebted countries reducing their levels of debt, by spending less and raising more in revenues.

On Friday, Italian Prime Minister Silvio Berlusconi announced plans to balance the country’s budget by 2013, a year earlier than planned, while Spain has also promised to speed up cost-saving measures.

Knock-on effects

S&P’s downgrade of US debt has also underminded investors’ confidence.

“The ratings downgrade has been an unprecedented event,” said Alvin Liew of UOB Bank in Singapore.

Standard & Poor’s cut the US’s top-notch AAA rating for the first time, citing concerns about the size of the country’s budget deficit and the acrimonious and protracted battle in Congress to raise the country’s debt ceiling at the eleventh hour. It has graded the US at AA+.

The fear for many investors is that the US economy will slow further, and even enter a double-dip recession.

This in turn would hurt Asia, which relies on the US, the world’s biggest economy, to buy billions of dollars of exports every month.

It would also hamper efforts of governments to reduce their debt load, as it would cut tax revenues.

Gold standard

Fears of renewed global slowdown were reflected in the price of gold and oil.

Gold, which is seen as a safe investment in times of economic uncertainty, jumped to a new record high of $1,704 an ounce on increased demand.

Meanwhile the price of oil slipped further, reflecting concerns that weak global growth could lead to a fall in demand. US light crude fell 2.8% to $84.44 a barrel, while Brent crude lost 2.4% to $106.71.

“There are few places can obviously hide,” said Greg Gibbs of RBS in Sydney. “And the ones that can hide in are doing very well. Gold is the beneficiary because there is no central bank to sell it.”

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