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ECB's reaction seen as crucial to keep markets stable on Greece

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The European Central Bank's response to the mounting Greek crisis will prove crucial to maintaining market stability in the days ahead, according to strategists.

[LONDON] The European Central Bank's response to the mounting Greek crisis will prove crucial to maintaining market stability in the days ahead, according to strategists.

Its options, they said, include speeding up bond-buying under its quantitative-easing plan and re-activating the as-yet untested Outright Monetary Transactions programme, which also allows for debt purchases.

The Frankfurt-based ECB has been buying government bonds including those of Germany and Italy on Monday, according to three people familiar with the situation, who asked not to be identified because they're not authorised to comment. The purchases were about in line with what the central bank normally buys via QE, they said.

"We're in an uncharted territory, and reaction from the European Central Bank" will be "key to the markets," said Soeren Moerch, head of fixed-income trading at Danske Bank A/S in Copenhagen. "So far, the market has functioned better than I expected, but I would not rule out the ECB front-loading its QE program at a faster speed if things get worse."

European markets opened in volatile form on Monday after Greece imposed capital controls to stem the flood of funds from its financial system. With Prime Minister Alexis Tsipras having refused creditors' demands for extending aid beyond its Tuesday expiry date, Greece is on the brink of a crisis that could see it forced out of the euro.

The single currency tumbled as much as 1.9 per cent, the most since March, before paring that decline to leave it down 0.4 per cent at US$1.1122 as of 11:52 am London time. While Spanish and Italian government bonds plunged when markets opened, they pared losses quickly in a sign of investors' faith in the firewalls put in place since the financial crisis.

The response of the so-called European Stability Mechanism, a crisis backstop set up by the euro area in 2012 and which comprises measures including direct loans and debt purchases, will also be important to markets, Danske's Mr Moerch said.

The unused OMT plan is part of this programme and was introduced by the ECB in September 2012, after President Mario Draghi pledged to do "whatever it takes" to preserve the euro. It allows the central bank to buy government bonds maturing in one to three years from countries which sign up to a formal bailout and reforms.

JPMorgan Chase & Co analysts suggested the ECB start what they called an "Anti-Contagion Purchase Programme" if conditions deteriorate. The programme, the analysts said, could allow policy makers to buy a country's bonds if they judged its bond yields were out of line with economic fundamentals.

The ECB will probably re-activate its OMT program, said Vincent Chaigneau, London-based global head of rates and foreign-exchange strategy at Societe Generale SA.

"The ECB is likely to intervene in case of extreme market moves," said Mr Chaigneau. "We believe the central bank has enough tools to deal with the situation."

BLOOMBERG

Read more on the Greek crisis here