Trichet buys Europe some time

The boss of the European Central Bank, the stern-faced Jean-Claude Trichet, scored a big tactical victory overnight, but it's still far from certain that he'll be successful in stopping the spread of the eurozone debt crisis.

Interestingly, Trichet outplayed the markets because he threw out the rule book that central bankers normally use. Instead of "jaw-boning” markets, and threatening that the ECB would buy up huge quantities of Portuguese and Irish government bonds to stop their bond yields from pushing even higher, Trichet promised the bare minimum.

At a press conference in Frankfurt, Trichet said the central bank would keep buying the bonds of debt-laden eurozone countries, but he certainly didn't commit to any definite figure. This came as a disappointment to those traders who were hoping that Trichet might commit the ECB to buying €1 trillion ($US1.3 trillion) or so of Portuguese, Irish and Spanish bonds.

He also confirmed the widespread expectation in financial markets that the ECB would abandon its previous plans to wind down the emergency support for banks. Trichet confirmed the central bank would continue to offer unlimited loans to banks for periods of up to three months until at least next April.

Trichet's comments were distinctly underwhelming, but his strategy contained a cunning element of surprise. While Trichet was talking, the ECB embarked on an aggressive buying spree. Speculation that the ECB was looking to spend €100 million buying Portuguese and Irish bonds swept through the markets, sending bond yields of the troubled eurozone countries sharply lower.

To put the ECB buying into perspective, the bank has spent only €67 billion buying the bonds of troubled eurozone countries – mainly Greece and Ireland – since it first announced its controversial bond-buying program in May, at the height of the Greek debt crisis.

The effect of the ECB surprise tactic was immediate. Yields on 10-year Portuguese bonds tumbled by more than half a percentage point to 5.92 per cent, while Irish yields dropped by more than a quarter of a percentage point to 8.3 per cent. And even Spanish bond yields benefited, dropping to 5.09 per cent, even though the ECB did not buy Spanish bonds.

But even though Trichet scored an impressive victory overnight, some question how much money the ECB is really prepared to spend buying up the debt of problem eurozone countries.

When the ECB first unveiled its program in May, Bundesbank president, Axel Weber, made no secret of the fact that he had voted against the proposal, because of inflationary concerns.

Other critics of the scheme worry that buying government debts, the ECB is straying into fiscal, rather than monetary, policy. And, they say, it leaves the ECB with a huge quantity of dubious quality bonds on its balance sheet, which could result in heavy losses for the central bank if one of the debt-laden eurozone countries eventually does decide to default on its debt.

As a result, many believe that it won't be too long before financial markets call Trichet's bluff, and test just how much the ECB is prepared to spend to prop up Portugal.