The European Central Bank's unprecedented cash injection iseasing borrowing costs for Italy, Spain and Belgium, compensatingfor the lack of a solution to the debt crisis and the risk ofrecession.

Two-year Italian yields have dropped by 50 basis points andBelgian notes of the same maturity have declined by 22 basis pointssince Dec. 21, when the ECB supplied banks with 489 billion euros($636 billion) of three-year loans. Short-dated Italian and Spanishdebt outperformed AAA rated German and Dutch securities during thatperiod.

“Short-term borrowing costs have come down significantly andthat certainly helps to buy time,” said Jens Nordvig, managingdirector of currency research at Nomura Holdings Inc. in New York.“Six weeks ago, it looked as if there was going to be an imminentfunding crisis, but that's averted by the ECB's moneyinjection.”

The ECB, led by President Mario Draghi, cut its key interestrate last month for the second time in a quarter and offeredunlimited three-year cash at 1 percent to persuade banks, saddledwith deteriorating assets including bonds from so-called peripheralEurope, to keep providing credit to the region. Some of that moneyis probably being invested in sovereign debt, said FabrizioFiorini, who helps oversee $8 billion as chief investment officerat Aletti Gestielle SGR SpA in Milan.

Italian notes maturing within three years handed investors a0.56 percent gain since Dec. 21, beating a 0.14 percent return fromGerman debt and a 0.2 percent advance for Finnish securities, bondindexes compiled Bank of America Merrill Lynch show. Spanish notesreturned 0.78 percent. The Stoxx Europe 600 Index has risen 5.6percent since the ECB allotted the funds.

“Some of the cash and the liquidity the ECB has provided islikely to be recycled into peripheral debt,” Fiorini said. “Thisshould allow Italy and Spain to raise money at lower borrowingcosts, at least in the first quarter.”

Italy sold 9 billion euros of bills on Dec. 28 at about half therate of the previous sale in November. It auctioned bonds due March2022 the next day at an average yield of 6.98 percent, down fromthe 7.56 percent it paid at a Nov. 29 sale.

Belgium, whose credit rating was cut two steps by Moody'sInvestors Service on Dec. 16, raised more money than planned at aJan. 3 debt sale as borrowing costs fell to the lowest level in 18months. It sold 2.44 billion euros of three- and six-month treasurybills, compared with a target of 2.2 billion euros.

Recession Risk

The European Commission cut its 2012 growth forecast by morethan half to 0.5 percent in November, while Luxembourg PrimeMinister Jean-Claude Juncker said yesterday that the region is “onthe brink of a recession of which one doesn't yet know its scope.”The euro posted its first back-to-back annual losses against thedollar in a decade last year.

Standard & Poor's said Dec. 15 that it was reviewing thecredit ratings of 15 euro nations for a possible downgrade,including AAA rated Germany and France, citing “systemic stress inthe euro zone.”

France sold 7.96 billion euros of bond maturing in 2021, 2023,2035 and 2041 today, with borrowing costs rising in its firstauction of the year. The debt maturing in 2021 was sold at anaverage yield of 3.29 percent, up from 3.18 percent in the previousauction on Dec. 1.

With European leaders failing to come up with what GermanChancellor Angela Merkel described as a “big-bang” solution to thecrisis, the ECB has taken unprecedented steps to prevent the crisisfrom spreading. The 489 billion euros it lent to 523 banks lastmonth exceeded the median estimate of 293 billion euros in aBloomberg News survey of economists. The central bank will offer asecond three-year loan on Feb. 28. A report last month showed itsbalance sheet swelled to a record 2.73 trillion euros on increasedlending.

The central bank has also bought bonds to curb rising yields.Italy's 10-year borrowing cost topped 7 percent in November, thelevel that prompted Greece, Portugal and Ireland to seek bailouts,and has been stuck at about 6.9 percent this week.

At 4.57 percent, Italy's two-year funding cost is below itssix-month average of 4.69 percent, and down from more than 7.66percent on Nov. 25. Spanish two-year yields of 3.48 percent havedropped from more than 6 percent six weeks ago.

“If you look at short-dated Italian or Spanish bonds, there issome evidence that the money from the ECB is being used to buythese bonds,” said Mohit Kumar, head of European fixed-incomestrategy at Deutsche Bank AG in London. “The ECB's role is crucialin containing the crisis. It may have constraints it needs to thinkof, but it's not without policy tools.”

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