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ECB's QE shield holds as EU turns screws on Greece: Euro credit

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While Greek Prime Minister Alexis Tsipras is buffeted by markets with each twist of his debt negotiations, the rest of the euro region is sheltered by US$1.3 trillion of central bank money.

[MADRID] While Greek Prime Minister Alexis Tsipras is buffeted by markets with each twist of his debt negotiations, the rest of the euro region is sheltered by US$1.3 trillion of central bank money.

The European Central Bank's plan to buy at least 1.1 trillion euros of bonds to boost inflation across the currency union is shielding the bloc's other debtor nations during the latest phase of the Greek crisis. The cost of borrowing for Italy, Spain and Portugal has barely moved even as Greek yields surged following Mr Tsipras's Jan 25 election victory.

Greek Finance Minister Yanis Varoufakis is heading into a second meeting with his euro-area colleagues on Monday after failing to agree a formula for keeping his country afloat this week. Yet unlike the earlier phases of the European debt crisis when Greece's euro status was in question, investors are still funding Italy, Spain and Ireland at record low rates.

"There have been virtually no signs of contagion," Simon Derrick, chief markets strategist at Bank of New York Mellon Corp. in London, said in a note to clients. "The ECB's quantitative easing program has helped establish a firewall around Greece that has both dampened the impact of yet another round of discussions over Greece's debt as well as provide a safety net should Greece end up leaving." 

The gap between the yields on debt issued by Greece and Italy, the European Union's most-indebted countries, more than doubled in the last year, according to data compiled by Bloomberg. Investors get an extra 8.37 percentage points to hold Greece's 10-year debt compared with similar securities issued by Italy. That compares with a gap of 2.69 percentage points in April 2014, the lowest in almost five years.

Spain's debt is yielding even less than Italy's as Prime Minister Mariano Rajoy targets the fastest economic growth since 2007 for the euro-region's fourth-largest economy, while Portugal's 10-year bonds are trading within 20 basis points of a record low for the euro era.

"Beyond near-term volatility I don't think Italy or Spain would suffer from a Greek standoff thanks to the upcoming ECB QE," said Axel Botte, a Paris-based strategist at Natixis Asset Management, which oversees 310 billion euros of assets including Spanish and Italian bonds. Mr Botte has stayed away from Greek bonds since 2011.

There is a danger of complacency as the bond market assumes Greece is unlikely to be expelled from the euro, according to some investors and analysts.

That's encouraging European policy makers to be tougher in negotiations because of the notion that a Greek exit would be survivable for the euro region, Chris Attfield, a fixed-income strategist at HSBC Holdings Plc in London, said last week.

While relative yields show investors' demand for Greek debt is decoupling from other southern European issues, Greek bond prices also have rebounded from the 15-month low seen at the end of last month as Mr Tsipras and Mr Varoufakis inch toward a settlement with their official creditors.

"I bought Greek bonds after elections and keep adding," Lutz Roehmeyer, who oversees US$1.1 billion of assets at Landesbank Berlin Investment GmbH, said on Monday. "Greece will stay in the euro zone and a debt solution is possible after hard negotiations."

Greece's 1.74 billion euros of bonds due 2025 are trading 59.52 cents on the euro compared with 54.46 cents on Jan 30, according to data on bid prices compiled by Bloomberg.

While the country's leverage exceeds 320 billion euros ($365 billion), or about 180 per cent of the country's gross domestic product, the risk of contagion across debt markets is also limited because 75 per cent of the debt consists of bailout loans provided by the European Union and International Monetary Fund instead of investors. The debt-to-GDP ratio for the whole euro area is 91 per cent, Eurostat says.

"To avoid a default and exit from the European monetary union, Greece urgently needs fresh financial aid," Henry Skeoch, a strategist at Barclays Plc in London, said in a note. "We see the euro government bond market, especially peripheral bonds, as exposed to contagion but think the magnitude of this would likely be much lower than during the euro-zone debt crisis."

BLOOMBERG