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Citi interest rates strategist Jamie Searle pours cold water on hopes that the ECB will swoop in and save the day in Spain (and Italy). In a note to clients, he cautions:Don’t count on Securities Market Programme (SMP) reactivation: There appear to be growing expectations in the last couple of days that the SMP will be reactivated imminently, probably fuelled by comments from Spain and Italy appealing to the ECB to lower spreads. This appears to be wishful thinking. The ECB are likely to act at the next meeting on 5 July, probably with a rate cut and more liquidity provision. However, a reactivation of the SMP and/or a target spread level seem highly unlikely to us at this stage.
Further Long-Term Refinancing Operations (LTROs) are likely to bring only temporary relief: Even if the ECB do announce extra liquidity provision, we are not convinced even this will stem the rise in periphery yields for long. A new LTRO (3yr or longer) should help support periphery auctions going forward, but we suspect that large concessions will still be needed as domestic banks, already heavily laden with domestic sovereign debt, make room to buy primary issuance by selling in the secondary market. If this scenario proves right, further LTROs are likely to prompt a knee-jerk tightening in spreads, but this would be the signal to sell in our view.
In other words, not only do further LTROs display diminishing returns at this point, but they could even make the liquidity situation in the sovereign bond market much worse. Searle says that sovereign issuance in Spain is being propped up “almost entirely thanks to domestic support.” One could therefore conclude that there are no buyers of Spanish government debt that could step in and prevent such a scenario of a continued rise in Spanish yields due to banks dumping sovereign bonds in the secondary market.
Just exactly why is something like the Securities Market Programme — which BofA yesterday postulated would be used by the ECB soon to address the crisis in Spain — out of the picture? Searle told Business Insider:
The ECB has never been keen on the SMP, and now the EFSF (and eventually the ESM) has the capability of buying in the secondary market. The ECB would prefer to see the politicians take the initiative and, if necessary, use the financial rescue mechanisms accompanied with appropriate conditionality.
The ECB are likely to use other policy tools first — LTROs, rate cuts, wider collateral. We think a reactivation of the SMP and/or wider QE will only become more likely if deflation seriously threatens.
So, before the ECB could actually alleviate the stress in Spain, it will likely make things worse if it chooses to act.
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