European Central Bank arms itself for Spanish crisis

Spain's government and banks have to refinance almost ?300bn of debt next year, leaving the country prey to a buyers' strike Photo: AFP

The ECB said it would raise its subscribed capital by €5bn (£4.2bn) to €10.76bn, the first increase since the launch of the monetary union.

"Basically they are insuring themselves in case they have to step up bond purchases, and that probably implies Spain," said Julian Callow from Barclays Capital. "They have to be ready to dig the fire-break early on this because Spain is too large to handle, and there is risk of contagion to Italy."

The ECB's move came as Spain braved the debt markets following a downgrade alert by Moody's. Madrid paid the highest interest rates for a decade with yields on 10-year bonds rising to 5.45pc, compared with 4.63pc in November.

Spain's government and banks have to refinance almost €300bn of debt next year, leaving the country prey to a buyers' strike. "The auction wasn't a disaster but the markets are going to lose patience very quickly if the bond spreads widen further," said Elizabeth Afseth from Evolution Securities.

The ECB has so far bought €71bn of Greek, Irish, and Portuguese bonds in a bid to cap yields, but this was done against Bundesbank objections, and may breach EU treaty law. Jean-Claude Trichet, the ECB's president, is irked that the bank is having to shoulder the burden of propping up the EMU periphery, blurring the lines between fiscal and monetary policy. Critics in Germany say the ECB is turning into a "bad bank" for toxic debts.

Mr Trichet has tried to nudge EU leaders into taking over the task by deploying the EU's €440bn rescue fund in eurozone debt markets, meeting German resistance.

Officials fear that the ECB could face losses on bond purchases, as well as loans worth €334bn to Greek, Irish, Portuguese, and Spanish banks – much of it in exchange for suspect housing collateral. Barclays Capital said eurozone central banks have already lost about €5bn.

A report by Goldman Sachs said EMU states hold $760bn (£487bn) of Spanish debt securities, on top of other loans, or
three-quarters of all foreign holdings. "Debt sustainability in the European periphery is to a very large extent a domestic problem for the eurozone," it said.

France has $252bn, Germany $212bn, Luxembourg $77bn, Ireland $62bn, The Netherlands $61bn, and Belgium $48bn. Outside EMU, Britain has $69bn and the US $26bn.

The loss profile is different to the US housing crisis, when European creditors were heavily on the hook. American banks will not return the favour by absorbing big losses if the EMU debt woes escalate.

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