ECB scales back government bond purchases after yields fall

The illuminated euro sign is seen in front of the headquarters of the European Central Bank (ECB) in Frankfurt April 5, 2011.

FRANKFURT (Reuters) - The European Central Bank reduced its bond purchases last week to 14.3 billion euros (12.5 billion pounds) from 22 billion a week earlier, scaling back its market intervention after its first bout of buying helped Italian and Spanish debt yields to ease.

The ECB reactivated its controversial bond-buying programme earlier this month after Italy and Spain nearly succumbed to a fierce market attack which threatened to overwhelm euro zone government's efforts to resolve the debt crisis.

The intervention has worked insofar as yields on Italian and Spanish bonds have dropped to around 5 percent from levels above 6 percent before the ECB stepped in.

Berenberg bank economist Christian Schulz expected the volume of purchases the ECB makes to decline further as long as no fresh market turbulence is triggered.

"Still, the large figure signals that the ECB remains committed to defending sustainable yields for the two countries," Schulz said.

The amount purchased last week, reported by the ECB on Monday, was in line with the 14 billion euros seen in a Reuters poll.

The central bank's latest purchases, which span the period of August 11-17, send the programme's total past the 100 billion euro mark to 110.5 billion euros.

The ECB does not break down the purchases. However, traders say it has been concentrating its efforts on Italian bonds and that it is continuing to buy.

It resumed its purchases following a 19-week pause in the programme, despite opposition from a four-man group on its policymaking Governing Council, led by Germans Jens Weidmann and Juergen Stark.

The Bundesbank, of which Weidmann is president, renewed its attack on secondary market bond purchases earlier on Monday, saying they reduce incentives for "appropriate fiscal policy.

Commerzbank economist Michael Schubert said the latest bond purchases figures showed a similar pattern to May 2010, when the ECB began the bond-buy programme with 16.5 billion euros worth of purchases before rapidly reducing its intervention.

"The ECB Council's dilemma can be seen in the figures," he said. "They have to buy to stabilise and they have stabilised. But there is an unmistakable reluctance to buy at all."

Monday's latest figures of 14 billion euros was the third largest amount it has purchased since it began its Securities Markets Programme last May.

Critics of the purchases say they push the ECB into the fiscal policy arena, overstepping its mandate and threatening its independence.

A majority of the bank's policymakers, however, felt obliged to act as action from euro zone governments failed to stem the spread of the bloc's debt crisis towards Italy and Spain, two of the bloc's largest economies.

The ECB has said it will "actively implement" the programme although board member Juergen Stark said on Friday it was a temporary measure designed to buy time for troubled members.

The ECB agreed to reopen the bond-buy programme after promises from European governments that the European Financial Stability Facility would take over this task within months.

However, the ECB may have to keep up the plan longer than it expected.

Ewald Nowotny, a member of the ECB's Governing Council, said earlier on Monday he was worried that political jousting in member states could end up delaying beyond October parliamentary approvals of the July 21 deal that would empower the EFSF to buy bonds.

The bond purchases take 2-3 days to settle, meaning that when the ECB is buying, the weekly figures do not necessarily give the full picture.

It and the 17 euro zone national central banks can buy government and corporate bonds from banks and other investors under the programme, but not directly from governments.

As usual, the ECB will take one-week deposits from commercial banks on Tuesday to neutralise the monetary impact of the purchases and the inflationary pressure they create.

(Editing by Toby Chopra)