European Central Bank aid injection eases Portuguese debt

By Chris Graeme [email protected]

Interest rates on 10-year Portuguese sovereign bonds have tumbled from 7.2 per cent to 6.4 per cent thanks to European Central Bank intervention.

The pressure on Portuguese bonds eased after the Governor of the ECB, Jean-Claude Trichet, announced last week that the European financial institution would be extending temporary financing measures to EU member states and banks.

Plummeting yield rates on bonds have revealed that the world’s financial markets only have confidence in the European Central Bank when it comes to resolving the public debt crisis affecting Eurozone countries.

Last week the IMF and EU approved a huge €700 billion rescue package for Ireland’s struggling economy and banking system, extended loan time deadlines and terms to Greece and announced an agreement to set up a permanent emergency support fund which will not affect investors.

Even so, interest rates on Irish, Spanish and Portuguese sovereign bonds continued to rise last week.

Then, on Thursday, the ECB president announced that financial support measures offered to member states would be extended.

The result was the largest fall in bond interest rates since May.

Portuguese sovereign 10-year bonds closed on Thursday 0.4 percentage points down on the previous day.

On Friday, Bloomberg reported that the ECB had bought Irish and Portuguese bonds, according to at least four traders in the know.

The ECB also bought Greek debt although this had not been confirmed.

One analyst, Peter Chatwell from Credit Agricole Corporate & Investment Bank in London told Bloomberg that the “timing for the bond purchases was perfect” because they would “move the market in a big way”.

The result boosted market confidence on Friday with Portuguese yields falling 20 basis points to 6.11 per cent and even Greek yields tumbling 12 basis points to 11.72 per cent.

Did you know?…

A government bond is a bond issued by a national government denominated in the country’s own currency. In this case Euros.

Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds.

The first ever government bond was issued by the English government in 1693 to raise money to fund a war against France.

Government bonds are usually referred to as risk-free bonds, because the government can raise taxes to redeem the bond at maturity.

There have been examples where a government has defaulted on its domestic currency debt, such as in Russia in 1998 (the “rouble crisis”), though in the past this has been very rare.

However, following the world financial crisis in 2007 and worries over European public debt which is financed on the back of bonds, international investor concerns over currency debt defaults have been at the centre of this current European debt crisis which was sparked by Greece last year and now threatens Ireland, Portugal, Spain and Italy.

Other risks exist, such as currency risk for foreign investors (for example non-US investors of US Treasury securities would have received lower returns in 2004 because the value of the US dollar declined against most other currencies).

Secondly, there is inflation risk, in that the principal repaid at maturity will have less purchasing power than anticipated if the inflation outturn is higher than expected.

Many governments issue inflation-indexed bonds, which should protect investors against inflation risk. Bonds are issued by public authorities, credit institutions, companies and supranational institutions in the primary markets.

The most common process of issuing bonds is through underwriting. In underwriting, one or more securities firms or banks, forming a syndicate, buy an entire issue of bonds and re-sell them on to investors. The security firm takes the risk of being unable to sell on the issue to end investors.

However, government bonds are instead typically auctioned. A bond is a debt security, in which the authorised issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) and/or to repay the principal at a later date, termed maturity.

A bond is a formal contract to repay borrowed money with interest at fixed intervals. Thus a bond is like a loan: the issuer is the borrower (debtor), the holder is the lender (creditor), and the coupon is the interest.

Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure. Certificates of deposit (CDs) or commercial paper are considered to be money market instruments and not bonds. Bonds must be repaid at fixed intervals over a period of time.