The European Central Bank’s resolve in staying out of the bond market since March is being tested as soaring interest rates endanger the funding programs of Europe’s most indebted nations. Italian 10-year yields surged above 6 percent this week on concern that Europe’s third-largest economy may fail to implement a 40 billion-euro ($56 billion) austerity package. Borrowing costs for the nation, which plans to sell more than 3 billion euros of bonds in four auctions with maturities from 2016 to 2026, retreated yesterday amid speculation about ECB purchases. The Frankfurt-based central bank declined to comment. “The ECB will intervene on whatever scale is necessary to allow Italy to conduct its auction on Thursday,” Willem Buiter, chief economist at Citigroup Inc. and former Bank of England policy maker, told reporters in London yesterday. “If the ECB doesn’t come in, the Italian bond auction is likely to fail.” The ECB suspended its bond-market support 15 weeks ago as policy makers including incoming president Mario Draghi stressed that the program is temporary and designed to enforce the bank’s monetary policy aims. Opponents of the so-called Securities Markets Program have argued the purchases stretch the ECB’s mandate and may fuel inflation. With the crisis moving closer to the heart of the 17-nation currency region and policy makers failing at a meeting in Brussels this week to agree on measures to curtail contagion and cut Greece’s debt load, the ECB may have to restart the program, economists said. Unlimited Funds “The central bank can create an unlimited amount of money to purchase as much debt as it wants without anything troublesome like parliamentary approval,” said David Mackie, chief European economist at JPMorgan Chase & Co. in London. “However, our judgment is that the central bank would be very reluctant to get engaged in this way. The ECB would prefer a fiscal solution to what is obviously a fiscal problem.” Warnings by Moody’s Investors Service and Standard & Poor’s over Italy’s ability to trim its debt burden, coupled with infighting in Silvio Berlusconi’s government over budget cuts, fueled the selloff that started last week. The country yesterday sold 6.75 billion euros of 12-month bills, the first auction since borrowing costs began soaring. A bigger obstacle to the ECB re-entering bond markets may be that, with the total outstanding amount of Italian government debt amounting to 1.6 trillion euros, the financial firepower would need to be much larger than for smaller states. Too Big to Rescue? “The practical problem is that the Italian bond market is many times bigger than those of even Greece, Portugal and Ireland put together,” said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. “The ECB might find it difficult to have the necessary impact while still sterilizing the purchases.” Since the beginning of the ECB’s bond purchases in May 2010, the central bank has purchased bonds worth 74 billion euros from the region’s debt-strapped periphery. Unlike the U.S. Federal Reserve’s Quantitative Easing program, the ECB re- absorbs the cash it lays out, to restrain money supply growth. ECB President Jean-Claude Trichet has repeatedly said the bank has done its part in fighting the debt crisis and that it’s now up to governments to design solutions. “We are not the decision makers and we do not want to substitute for decision makers,” Trichet said on July 7 after the ECB raised interest rates for the second time this year. “We are not the actors. The governments and authorities are the actors.” Buyback Program Trichet has also called for more flexibility of the European Financial Stability Facility, suggesting that bond buybacks should be added to the facility’s instruments. Ireland and Portugal, which both received external aid over the past year, have tapped the EFSF. European finance chiefs this week debated adding buybacks to the fund’s arsenal and increasing its size from the current 440 billion euros, in an effort to stem the crisis and restore investor confidence in the 17-member region. Officials are still working on a second package for Greece to follow the 110 billion-euro lifeline extended in May 2010. “ECB bond purchases are the most powerful circuit breaker,” said Holger Schmieding, chief economist at Joh. Berenberg Gossler & Co. in London. “The earlier the ECB delivers on its duty to tackle contagion risks, to safeguard financial stability and to prevent harm to the euro-zone economy as a whole, the easier it will be to contain the damage.” To contact the reporters on this story: Jeffrey Black in Frankfurt at jblack25@bloomberg.net; Jana Randow in Frankfurt at jrandow@bloomberg.net To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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