European Central Bank President Jean-Claude Trichet startedbuying Italian and Spanish assets today in his riskiest attempt yetto tame the sovereign debt crisis.

Italian and Spanish bonds surged as the ECB entered the market,sending 10-year yields down more than 70 basis points. The eurorose to $1.4355 at 10:30 a.m. in Frankfurt from $1.4277 at theclose of European trading on Friday.

With governments failing to act swiftly enough to stop contagionfrom Greece's fiscal meltdown, it has fallen to the ECB to battle acrisis that's now threatening the survival of the euro. BuyingItalian and Spanish debt may require the ECB to massively expandits balance sheet and open it to accusations of bailing outprofligate nations, breaching a key principle in the euro'sfounding treaty and undermining its credibility. Germany'sBundesbank opposes the move.

“The ECB's credibility unfortunately has taken a real batteringand it is now at the mercy of governments,” said Tobias Blattner, aformer ECB economist now at Daiwa Capital Markets Europe in London.He estimates the central bank will have to buy about 200 billioneuros ($287 billion) of Italian bonds and 60 billion euros ofSpanish securities to make an impact.

Italy has 1.8 trillion euros ($2.6 trillion) in outstandingdebt. The ECB bought Italian and Spanish bonds this morning,according to five people with knowledge of the transactions,driving their 10-year yields down to 5.39 percent and 5.3 percentrespectively from above 6 percent on Friday. Both reached euro-erarecords last week.

Stocks Decline
European stocks declined.The benchmark Stoxx Europe 600 Index was down 0.4 percent to 237.85at 9:25 a.m. in London after earlier sinking as much as 1.5percent. U.S. futures on the Standard & Poor's 500 Indexretreated 2.5 percent.

ECB policy makers were forced to step up their response to thedebt crisis after a failure to enter the Italian and Spanish bondmarkets last week helped fuel a global rout.

“It looks like the ECB has decided to bring out the bazooka,”said Douglas Borthwick, head of foreign-exchange trading atStamford, Connecticut-based Faros Trading.

Fears of a further slump when markets opened this week werecompounded by Standard & Poor's decision on Friday to strip theU.S. of its AAA credit rating for the first time.

Asian stocks dropped today, extending the worst global slumpsince the bull market began in 2009.

G-7 Statement
The Group of Seven nationsissued a statement this morning saying it will take “all necessarymeasures to support financial stability and growth.”

In a statement issued in the name of the ECB president after anemergency Governing Council conference call last night, theFrankfurt-based central bank welcomed Italy and Spain's efforts toreduce their budget deficits and said it will “actively implement”its bond-purchase program.

Since starting its bond purchases in May last year, the ECB hasbought about 74 billion euros of assets to help stabilize Greek,Irish and Portuguese markets — the three countries of the euro areato have received bailouts from the European Union and InternationalMonetary Fund.

Four months ago, the ECB ceased bond purchases and put the onuson governments to find a solution to their debt woes as it turnedits attention to raising interest rates to curb inflation. Now itfinds itself once again in the vanguard of efforts to overcome thecrisis.

Sterilization
Because the ECB will have tospend considerably more to have an impact on the bond markets ofthe euro area's third- and fourth-largest economies, it may not beable to continue to sterilize its purchases by absorbing theequivalent amount from banks via term deposits, said CarstenBrzeski, senior economist at ING Belgium in Brussels.

That would amount to swelling the money supply, or quantitativeeasing, which may in turn fuel inflation.

“I don't think that very large volumes — like 50 billion a week— can be sterilized,” Brzeski said. “Then they risk throwing theirvery last principle overboard.”

The ECB, which is also lending banks unlimited amounts of cashat its benchmark rate of 1.5 percent, has always said its so-callednon-standard measures are “temporary.”

Last night it reiterated that the bond program aims to helprestore “a better transmission of our monetary policy” and“therefore to ensure price stability in the euro area.”

EFSF Purchases
It also called on alleuro-area governments to follow through on the steps they agreed toJuly 21, including allowing the European Financial StabilityFacility to purchase bonds on the secondary market.

Jacques Cailloux, an economist at Royal Bank of Scotland GroupPlc, said he expects the ECB to buy on average around 2.5 billioneuros of bonds a day, which would amount to about 600 billion eurosif maintained over a year. While the ECB may be playing for timeuntil the EFSF is ready to take over bond purchases, between themthey may be forced to hold “close to half of the traded Italian andSpanish debt, or around 850 billion euros,” Cailloux said.

While ECB bond purchases could act as a “circuit breaker,” theyare not a solution, said Michala Marcussen, head of globaleconomics at Societe Generale SA in Paris.

“The real solution is for the euro area to move to some form offiscal union,” Marcussen wrote in a note to clients today. “We seethe next step in this process to increase the size of the EFSF toat least 1.5 trillion euros. This will be politically difficult,and all the more so at a time when the most recent adjustments tothe EFSF are still pending ratification by nationalparliaments.”

The 440 billion-euro rescue fund currently has about 323 billioneuros left at its disposal.

In a joint statement yesterday, French President Nicolas Sarkozyand German Chancellor Angela Merkel called Italy's decision tobalance its budget in 2013, a year ahead of schedule, of“fundamental importance.” They also called for their parliaments toapprove the strengthening of the EFSF by the end of September.

Bloomberg News

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