The European Central Bank stepped into bond markets on Monday, backing up a pledge to support Spain and Italy with the aim of averting financial meltdown in the euro zone, while the G7 and G20 offered soothing words to investors shaken by a historic downgrade of the U.S. debt rating.

Spanish and Italian bond yields fell as traders said the ECB was broadening its bond-buying program to include debt issued by the bloc's third- and fourth-biggest economies, in the latest effort to staunch Europe's sovereign debt crisis.

"They're doing 20 to 25 million (euro) clips and they're spreading it around the market," said a trader. "We expect them to do billions today."

Equity markets that had been in headlong retreat in Asia turned positive in Europe as G20 finance chiefs and central bankers pledged to take all necessary measures to support financial stability, growth and liquidity.

"It does seem that policymakers globally are swinging into action," said Shane Oliver, head of investment strategy at AMP Capital Investors, one of Australia's biggest fund managers.

"A move to now start buying Italian bonds could be very positive in helping to calm fears about a further escalation of European debt problems," said Oliver, speaking before the ECB made its move in the markets.

"Speculators will now have to think twice about selling or shorting Italian and Spanish bonds knowing the ECB will be acting against them."

Spreads of Italian and Spanish bonds over German debt narrowed sharply, credit default swaps fell and Spanish and Italian stocks jumped more than 3 percent. The euro also extended gains.

It marked a reversal of mood from the fear that had gripped Asian markets earlier in the day, when similar pledges in a G7 statement had failed to calm investors who drove safe haven gold to a record atop $1,715 an ounce, while share markets were again colored red.

Investors also turned their attention to what the Federal Reserve might say at its policy meeting on Tuesday, fuelling speculation it might soon have to consider a third round of quantitative easing to resuscitate the world's richest economy.

COUNTING ON ECB, FED

After a rare Sunday night conference call, the ECB welcomed announcements by Italy and Spain of new deficit cutting measures and economic reforms as well as a Franco-German pledge that the euro zone's rescue fund will take responsibility for bond-buying once it is operational, probably in October.

"The Euro system will intervene very significantly on markets and respond in a significant and cohesive way," a monetary source said.

The central bank had been reluctant to step up its buying of distressed debt, fearing it would be seen as a blank check to spendthrift governments.

Since the program began in May last year it has bought just 80 billion euros of bonds, while Italy and Spain alone issue around 600 billion a year. Dealers said it would take a pledge to buy several hundred billion euros of debt to get ahead of contagion fears.

At the same time the G7 -- the United States, Britain, Canada, France, Germany, Italy and Japan -- said it would take joint action if needed in foreign exchange markets because "disorderly movements ... have adverse effects for economic and financial stability."

The G20 communique followed shortly after European markets opened.

The Japanese intervened to restrain their currency last week while the Swiss National Bank surprised with a new round of easing as it fought a rapidly rising franc.

Pressure is now growing on the Fed to try further easing -- dubbed QE3 by the market -- though few expect anything dramatic as early as Tuesday's policy meeting.

"We are probably a little bit closer. But I don't think we're there yet," said Nomura's chief global economist Paul Sheard. "I think the Fed would have to get a little bit more concerned that financial markets were spinning out of control before accepting with QE3."

CHINA NOT HAPPY

None of which was enough to reassure Washington's single biggest creditor, China.

"It must be understood that if the U.S., Europe and other advanced economies fail to shoulder their responsibilities and continue their incessant messing around over selfish interests, this will seriously impede stable development of the global economy," said a commentary in the People's Daily newspaper, the mouthpiece of China's ruling Communist party.

China holds well over a trillion dollars worth of U.S. government paper and was thus not pleased when Standard & Poor's cut the U.S. debt rating to AA-plus from AAA -- a move that also angered Treasury Secretary Timothy Geithner.

In an interview on NBC and CNBC television, Geithner said the rating agency "has shown really terrible judgment" and claimed its downgrade meant nothing and wouldn't affect investors' faith in U.S. debt.

Japanese Finance Minister Yoshihiko Noda put a brave face on it on Monday, saying that market trust in the dollar and U.S. Treasuries has not wavered and indicated Tokyo's readiness to maintain its massive holdings of U.S. government bonds.