European markets rally to record high

EUROPEAN MARKETS rallied to their highest level since April yesterday, fuelled by the expectation that the European Central Bank will introduce measures at its meeting on Thursday to stabilise the sovereign debt crisis and stem the economic slowdown.

In Dublin, the Iseq index closed up by 1.4 per cent, in line with trends across Europe, buoyed by a healthy 2.4 per cent advance by Ryanair. The FTSE 100 touched the 5,700 level for the first time in 10 days to finish up by 1.2 per cent, while in Frankfurt the DAX powered to a 1.3 per cent gain and a strong performance from Air France-KLM saw the CAC 40 finish up by 1.2 per cent in Paris.

Speculation is mounting that an intervention is on the way, following the comments from ECB president Mario Draghi last week that the central bank would do whatever it took to preserve the common currency.

“The ECB has been hinting, hinting, hinting but now it’s the time to deliver,” said Henk Potts, market strategist at Barclays Wealth. “If they don’t do something concrete at Thursday’s meeting, the markets are going to see some hefty falls. There are no in-between measures this time; if the central bankers fail to deliver there is nothing else to underpin the market.”

According to Eanna Black, treasury analyst with Investec in Dublin, the most likely path the ECB will pursue is to resume its bond-buying programme to support Spain and Italy. He also suggests that the ECB might move to buy up bonds in the primary market for the first time.

While Germany has expressed its opposition to a resumption of this programme until now, Mr Black notes that support is now forthcoming from German politicians. Another possibility is that the ECB will repeat last month’s decision and announce a further rate cut of 0.25 per cent, bringing the main rate down to 0.5 per cent.

However, according to Mr Black, while this is a possibility, it is unlikely to happen until September, although the central bank “might catch the market out”.

“I feel they’ll hold off on the basis that the politicians have to do some work,” he says.

There has also been speculation that Europe’s new funding vehicle, the European Stability Mechanism (ESM) will get a banking licence, which would allow it to leverage up and increase its lending power.

The purpose of such measures is to stabilise the market and drive down yields of countries such as Spain and Italy.

Since Mr Draghi’s pronouncement, bond yields of peripheral European countries have fallen, indicating a reduced cost of funding.

Italy’s borrowing costs fell at a debt sale yesterday, as it sold €5.48 billion in bonds at an average yield of 5.96 per cent, down from 6.19 per cent a month ago.

Ireland’s cost of funding was also below the 6 per cent level yesterday, while Spanish 10-year yields dropped 13 basis points to 6.64 per cent, down from levels of about 7.5 per cent before Mr Draghi’s comments last week.

However, despite the improvement, some analysts noted that the cost of funding for Italy remains more than twice as high as that for countries such as Belgium.

This week might also see some sort of stimulus emanating from the US, where the Federal Reserve will meet today.

The Bank of England will meet on Thursday and, as Mr Black notes, “it has a habit of surprising you”.