The European Central Bank stepped in to stem an accelerating selloff of euro zone government bonds on Wednesday, traders said, after the United States called for more decisive action to halt the spreading sovereign debt crisis.
European shares and the bonds of weaker euro zone countries recovered initially on the move on the day Italian Prime Minister-designate Mario Monti was to name a national unity government to implement long-delayed structural economic reforms.
They're heavily in on Italy and Spain, 2-10 years, one trader said of the central bank intervention. Yields on Italian government bonds fell just below the 7 percent danger level, widely seen as unaffordable in the long term.
But ECB policymakers continue to reject growing international calls to intervene decisively as Europe's lender of last resort, stressing it is up to governments to resolve the debt crisis through austerity measures and reforms.
Shares and the euro have tumbled over the last week as bond market contagion spread to AAA-rated France, the euro zone's second economy and a mainstay of the currency bloc's rescue fund. The risk premium investors charge for holding French debt rather than benchmark German 10-year Bunds hit another euro lifetime high above 190 basis points on Tuesday.
President Barack Obama turned up the heat on Europe to act more boldly to extinguish the spreading bushfire.
Until we put in place a concrete plan and structure that sends a clear signal to the markets that Europe is standing behind the euro and will do what it takes, we are going to continue to see the kinds of market turmoil we saw, he said on a visit to Australia.
But there was no sign that Wednesday's bond-buying signaled a change in the ECB's policy of limited, stop-go purchases to stabilize markets temporarily while maintaining pressure on governments.
Obama said that whilst there had been progress in putting together unity governments in Italy and Greece, Europe still faced a problem of political will.
We're going to continue to advise European leaders on what options we think would meet the threshold where markets would settle down. It is going to require some tough decisions on their part, he said.
European Commission President Jose Manuel Barroso told the European Parliament the euro zone faced a systemic crisis and fragmenting the European Union was no solution.
He appeared to be referring to calls, notably from French President Nicolas Sarkozy, for a two-speed Europe with a much more integrated euro zone moving ahead of a looser confederation of non-euro members.
We are indeed now facing a truly systemic crisis that requires an even stronger commitment from all and that may require additional and very important measures, Barroso said.
We will not make the euro stronger through the fragmentation of the European Union.
In Greece, technocrat Prime Minister Lucas Papademos, a former ECB vice-president, was set to win a big confidence vote in parliament for his interim government despite the refusal of the main conservative leader to sign up to more austerity.
New Democracy party chief Antonis Samaras gave Papademos only arms-length backing, refusing to bow to EU demands for a written commitment to the bailout program and calling for elections in three months to restore social peace.
With Papademos' national unity coalition already split, rebuilding Greece's shattered finances to avert default will be a daunting task as Europe battles to prevent its debt woes from dragging down the world economy.
With financial markets skeptical that unelected technocrats will have the political clout to impose unpopular reforms, the two-year-old debt crisis risks engulfing the entire currency bloc and hurting global growth.
Wednesday's respite may be short-lived. U.S. policymakers have voiced alarm at growing signs of strain in the money market, the plumbing of the international financial system.
Banks in the euro zone face increasing difficulties in obtaining dollar funding, and while the stresses are nowhere near as acute as they were in the 2008 financial crisis, they have continued to mount despite ECB moves to provide unlimited liquidity to banks.
Asian shares and the euro fell earlier on Wednesday as signs that rising borrowing costs were affecting France stirred concern that the debt crisis has spread to the region's core.
Markets are clearly expecting a circuit breaker to alleviate pressure on periphery bond yields, said David Scutt, a trader at Arab Bank Australia in Sydney. If no announcement is forthcoming in the days ahead, one suspects that the situation could unravel fairly quickly.
Treasury Secretary Timothy Geithner said Europe had a difficult task in boosting the creditworthiness of some of its economies while also boosting growth.
With a Brussels-based think-tank warning that France's economy should be ringing alarm bells, Finance Minister Francois Baroin sought to calm fears about public finances.
We have the necessary room to maneuver within the budget to meet our 2012 deficit target even if the economy slows more than expected, he said in an interview in Wednesday's edition of Les Echos. Even with growth of 0.5 percent we can cope.
Baroin said the government was not working on a third savings package after announcing a second round of belt-tightening in three months last week in order to keep its deficit targets within reach, despite slowing growth.
Data on Tuesday showed the economy of the 17-nation euro zone barely grew in the third quarter. ECB President Mario Draghi has predicted the currency bloc will be in a mild recession by the end of the year.
Baroin told Les Echos he believed the ECB had an important role to play in calming the debt crisis, but he acknowledged, as did Geithner, that Germany had deep reservations.
Many analysts believe the only way to stem the contagion for now is for the European Central Bank to buy large amounts of bonds -- effectively the sort of quantitative easing undertaken by the U.S. and British central banks.
This has been anathema in Germany. But on Tuesday Peter Bofinger, a member of the group of economists that advises the German government, said the ECB should indeed become the euro zone's lender of last resort if the bloc's debt woes risked tearing apart the financial system.
If politics can't do it, then the ECB must do all it can to bring interest rates down to more reasonable levels, Bofinger said at Euro Finance Week.
($1 = 0.734 Euros)
(writing by Paul Taylor; editing by Janet McBride)