The European Central Bank's plan to buy bonds is proving moresuccessful at keeping borrowing costs for France and Belgium nearrecord lows than persuading investors to lend to Spain and Italyfor less.

Spain's three-year yield is back up to 3.83 percent afterdipping to 3.37 percent on Sept. 7, the day after ECB PresidentMario Draghi detailed his proposal to buy unlimited debt forcountries that agree to economic conditions in return for help.Since then, investors have lost 0.1 percent on Spanish debtrepayable in three year or less, and made 0.1 percent on Belgiannotes with similar maturities. The cost of insuring French debtagainst default has declined 24 percent, almost twice the 13percent drop in Italian default-swap costs.

“What Draghi has done has been beneficial to some degree, butthere's still skepticism in the market because Spain hasn't takenthe final step and asked for help,” said Adrian Owens at GAM Ltd.in London, which oversees $62 billion. “It doesn't change the factSpain still has a huge problem to tackle. France and Belgium areseen as a safer play.”

Spanish two-year notes yield 3.13 percent today, compared with0.24 percent on French securities. Italy's two-year borrowing costof 2.18 percent is more than six times higher than Belgium's 0.35percent rate.

The ECB program “sounds aggressive and the market ralliedinitially because investors don't want to stand in the way,” saidJohn Wraith, a fixed-income strategist at Bank of America MerrillLynch in London. “And then they realize they are not standing inthe way of anything. There is a process to go through first. Myview is that Spain will not voluntarily do it unless the marketforces it to.”

Spain has also underperformed Ireland, praised by European Unionleaders for its economic reforms. Irish bonds handed investors a4.6 percent gain since the ECB announcement, triple the Spanishbond gain of 1.5 percent, according to Bank of America MerrillLynch indexes. Italian securities gained 1.7 percent. Ireland soldbonds in July, returning to longer-term capital markets for thefirst time in almost two years.

The sovereign debt turmoil started in 2009 after Greece's newlyelected socialist government said the nation's budget deficit wastwice as big as previous leadership had disclosed. Since then,Greece, Ireland, Portugal, Spain and Cyprus have sought externalaid. Spain has already asked for as much as 100 billion euros ($130billion) for its banks. Italy and Spain won't request bailoutsunless a new surge in bond yields leaves them shut out of marketsas no government will voluntarily accept conditions imposed for theaid, Gianfranco Polillo, undersecretary of finance said in aninterview yesterday.

Testing Times

“There is a decent chance that even if Spain agrees to aprogram, there will be periods and reviews that it doesn't meet itsconditions,” said Nick Eisinger, a sovereign analyst with FidelityInvestment in London, which oversees $1.6 trillion. “If thathappens, the market will start speculating as to whether the ECBwill stop bond purchasing. There are still enormous macrochallenges in Europe and the growth outlook continues todeteriorate.”

Spain is in its second recession in three years, while its 24.6percent unemployment rate is Europe's biggest. The debt crisis hasalso pushed the whole euro region to the brink of recession, withECB forecasts showing the economy shrinking 0.4 percent thisyear.

Yields on Spanish bonds rose even after the country managed tosell 4.8 billion euros of 3-year notes and 10-year bonds yesterday,the most since January. The 10-year yield added 8 basis points to5.77 percent, after topping 6 percent earlier this week for thefirst time since the ECB announcement. The yield fell 6 basispoints to 5.71 percent.

Draghi said earlier this month that driving down borrowing costsfor countries willing to submit to a program of economic disciplineis justified because rising yields hamper the ECB's ability tochannel low interest rates to all of its 17 economies, leaving theregion at risk of a deeper economic slump.

“If you ask what has changed, the answer is not much,” said Bankof America Merrill Lynch's Wraith. “The measure may removenear-term risk, but the fundamental picture remains the same. I'mnot saying you should be playing games with the ECB as theyobviously meant what they said, but there is a process to gothrough first. I suspect the market will keep testing Spain'sresolve.”

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