The European Central Bank will buy eurozone government bonds to help
support fractured markets, abandoning firm resistance to full-scale
asset purchases in light of Greece’s debt crisis.

The ECB said in
a statement that the step, dubbed the ‘nuclear option’ by many
economists, was justified because of government promises to meet strict
budget targets and step up consolidation efforts.

Boosting its
firepower further, the ECB said it would also re-start dollar lending
operations and bring back some of the emergency liquidity measures it
had started to phase out.

“The European Central Bank decided on
several measures to address the severe tensions in certain market
segments which are hampering the monetary policy transmission mechanism
and thereby the effective conduct of monetary policy oriented towards
price stability in the medium term,” it said in a statement just after
European Union finance ministers announced their own 500 billion euro
crisis package.

On May 6, after the central bank’s monthly
meeting, ECB President Jean-Claude Trichet said policymakers had not
discussed buying government bonds.

 The scope of the purchases is
yet to be determined, but the ECB said they would be offset by
liquidity-absorbing operations so that the stance of monetary policy is
unaffected.

Under the plan the ECB will buy and sell both
government and private bonds on the secondary market.

“This
truly is overwhelming force, and should be more than sufficient to
stabilise markets in the near term, prevent panic and contain the risk
of contagion,” Marco Annunziata from UniCredit Group in London said of
the overall deal.

“Not only is the headline number stunning, but
the ECB’s decision to intervene in the secondary market should offset
concerns about the time it will take to deploy the stabilisation funds.”

The
fact that the bond purchases will be offset by liquidity absorbing
operations means they will not have the same potential impact on
inflation as straight purchases, such as those undertaken by the US
Federal Reserve and the Bank of England.

Arriving at the Bank for
International Settlemements for a second day of talks with fellow
central bankers, ECB President Jean-Claude Trichet said he would respond
to journalists’ questions later.

International Monetary Fund
chief Dominique Strauss-Kahn said market reaction to European
policymakers “bold steps” was heartening.

“I think we have to
wait a little more, but I think all this is rather encouraging,” he told
reporters on the sidelines of the BIS meeting.

Liquidity hose
In its early-morning
statement, the ECB said it would hold its next two three-month
liquidity operations at a fixed interest rate, rather than the planned
competitive tenders.

It will return to six-month loans, offering
banks all the money they ask for on May 12 at a fixed interest rate
linked to the main refinancing rate.

Speculation had increased
that the ECB would need to take drastic action to stem contagion from
Greece’s woes.

European laws prevent the ECB from buying debt
directly from governments in the way the US and British central banks
have done during the financial crisis, but not on the secondary market.

The
ECB announced a 60 billion programme to buy covered bonds last year but
this will be its first foray into buying government debt.

Greece’s
debt crisis has driven the cost of its sovereign debt and its insurance
to record levels. The problems have also started to push up debt costs
for other eurozone members with strained public finances such as
Portugal, Spain and Ireland.