Market disappontment as Spain and Italy call for fiscal integration

Spain and Italy welcomed the statement delivered by ECB president Mario Draghi, who said Europe’s central bank is ready to intervene in markets using non-conventional policies to lower debt costs and implement the decisions taken at the latest EU summit in June, but left markets in a mood of disappointment and uncertainty, failing to answer whether the two countries would request further help from the eurozone.

Meeting yesterday in Madrid after Draghi delivered his speech, Spain’s prime minister Mariano Rajoy and Italian premier Mario Monti jointly called for closer European financial integration, but failed to specify whether they would activate EU mechanisms to buy sovereign debt.

The market’s reaction to the series of announcements has been of palpable disappointment, according to Kevin Lilley, manager of Old Mutual’s European equity fund.

“Investors did not get the short-term fix they were looking for. The real message is that the peripheral economies will not be given money for nothing. The pressure for meaningful structural reform is to remain intense and any short-term bail out will be conditional and supervised by external agencies,” he said.

The lack of details and clear answers on how the ECB intends to help is very frustrating, according to Azad Zangana, European economist at Schroders.

“There are big questions around the scope and legality of its proposed policy tools. Will bond purchases be sterilised? How do they intend on dealing with the seniority issue with regards to existing bond holders. If the ECB does not follow up with some meaningful action in the near future, then there is a risk that markets lose all faith in Draghi and the governing council’s ability to tackle this crisis. Draghi warned investors not to bet against the Euro, but the trouble is those that are doing so have done rather well so far this year,” Zangana said.

Following the meeting, analysts expect further volatility to lie ahead.

“This week has been overloaded by key events triggering sharp volatility in the markets. Yesterday’s ECB meeting caught traders by surprise, as the initial reaction to the unchanged interest rate caused a surge by more than 100 pips. While Draghi tried to calm fears, trader mood was damaged,” said Andrey Dirgin, head of research at Forex Club.

EUR/USD opened today at 1.2182, and has now climbed back above 1.22.
Meanwhile, borrowing costs for Spain and Italy surged again, after a week in a more comfortable zone.

Yields on Spanish 10-year debt rose back above 7% yesterday and they are still trading above the 7% mark today.Italy’s 10-year yields rose to 6.31% yesterday and was at 6.17% in the morning.

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