A pledge of coordinated action by the world's industrial powers wedded to hopes of aggressive bond buying from Europe's central bank helped limit the fallout from the historic downgrade of the United States' debt rating in Asia on Monday.
With the twin debt crises raging and stock markets plunging, the Group of Seven leaders said after a telephone consultation that they were ready to take action to ensure stability and liquidity in financial markets.
That followed a surprise statement from the European Central Bank (ECB) that it would actively implement its controversial bond-buying programme to fight the euro zone's debt crisis. That stirred hopes it would buy Spanish and Italian government bonds to short-circuit financial market contagion.
It also whetted investor appetite for 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.
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.
He said the prospect of the ECB buying Italian and Spanish government bonds was particularly welcome.
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. Speculators will now have to think twice about selling or shorting Italian and Spanish bonds knowing the ECB will be acting against them.
It was enough to send the euro up a cent in Asian trading on Monday to stand at $1.4350, although traders have been disappointed so often by EU leaders that they were reluctant to take it any further.
The general aversion to risk was still clear in the price of gold, which hit a new record atop $1,693. Asian share markets were again colored red, although the losses were not as great as first feared. S&P 500 futures sank 2.5 percent at the opening, but pared those losses to 1.8 percent.
READY TO ACT
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.
A monetary source said this meant it is ready to start buying up the debt of these two countries.
The Euro system will intervene very significantly on markets and respond in a significant and cohesive way, the source said.
The central bank has been reluctant to step up its buying of distressed debt, fearing it would be seen as a blank cheque to spendthrift governments.
Since the programme 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.
On Sunday afternoon, German Chancellor Angela Merkel and French President Nicholas Sarkozy weighed in with a joint statement praising both Italy and Spain for their pledges to impose budget austerity.
They stressed that complete and speedy implementation of the announced measures is key to restor(ing) market confidence.
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 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.
The G7 has effectively drawn a line in the sand on contagion, said Christian Cooper, head of U.S. dollar derivatives rating at Jefferies & Co in New York.
The G7 meeting followed Friday's downgrading of U.S. debt quality by rating agency Standard & Poor's and a week in which a European debt crisis threatened to engulf larger nations as Italy's borrowing costs shot higher.
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 is thought to hold 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 risk free 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.
(Additional reporting by Laura McInnis, David Lawder and Mark Felsenthal in Washington, Sarah Marsh in Berlin, Astrid Wendlandt in Paris, Kim Yeonhee and Yoo Choonsik in Seoul, Praveen Menon and Shaheen Pasha in Dubai, and Reuters bureaux worldwide; Writing by Wayne Colele; Editing by Ed Davies and Dean Yates)