The cost of insuring debt issued by Spanish banks and by the sovereign against default fell on Monday on bets the European Central Bank could soon resume its bond-purchasing programme in a bid to bring Spain's borrowing costs to sustainable levels.
ECB President Mario Draghi said last week the central bank would do whatever it takes to protect the euro, prompting a majority of money market traders in a Reuters poll to say the central bank would soon re-start its bond-buying programme.
Some analysts are worried that the market is getting ahead of itself, but many say Draghi knows better than to gamble his credibility and will have to deliver some sort of action after his bold statement last week.
"Draghi has seemed to put his credibility on the line to a certain extent. You think he must have some confidence that he will be able to deliver something," Gavan Nolan, analyst at Markit said. "It's just a matter of whether what he has announced is enough."
In his boldest comments since taking the ECB's helm last November, Draghi pledged on Thursday to do whatever was necessary to protect theeuro zone from collapse, specifically mentioning high risk premiums on some sovereign debt. The comments have gone some way to easing pressure on Spanish funding costs, which are now comfortably below the 7 percent danger level and credit default swap prices.
But analysts are worried that any relief from such ECB action will be short-lived and that inaction would do a lot of damage given expectations.
CDS on Santander debt fell 25 basis points on Monday to 409 and the BBVA equivalent eased 16 bps to 426 bps. Those CDS prices hit record highs of 490 and 510 respectively last week, according to Markit data.
The cost of insuring Spanish debt against default fell 19 bps to 532 bps and the Italian equivalent was 14 bps lower at 484 bps. Spanish CDS also hit a record of 638 bps last week.
"I think expectations are high I think we would go to the previous wides (highs for CDS prices) if they did nothing," Michael Hampden-Turner, credit strategist, Citigroup.
"The market expects that he has something to announce, and that was a sort of a pre announcement. There is quite a strong risk that they get disappointed because we are sort of wondering what he could possibly have up his sleeve without (Germany) being in agreement."
The Bundesbank pushed back on Draghi's pledge last week and the ECB chief will also meet Bundesbank President Jens Weidmann, a strong opponent of the ECB's government bond purchase programme, ahead of Thursday's ECB meeting.
Chancellor Angela Merkel discussed the euro crisis with both French President Francois Hollande last Friday and then with Italian Prime Minister Mario Monti on Saturday.
After each call, the leaders issued joint statements pledging they would do everything to protect the euro zone, underscoring market expectations that something is in the works.
Given bond-purchases' fleeting impact in the past, it could well be that the ECB is mulling another form of action but only a bolder move than bond-buying would have a lasting impact, analysts said.
"We will probably see (CDS spreads) grind tighter in the run-up to the meeting. I think a lot of it will have been priced in already by that stage, depending on what the announcement on Thursday is, unless there is something more radical than the simple reopening of the Securities Markets Programme," Nolan said.
"Something like giving the ESM a banking license, that would be a game-changer, but I think it's pretty unlikely that that will be announced."
The ECB would like to see Europe's permanent bailout fund start buying the bonds of troubled euro zone members, but the fund's limited firepower could make its intervention less effective.
One idea, favoured by France, is to give the ESM access to ECB funding with a banking licence - something that 17 out of 24 money market traders expect to eventually happen, although they were divided on when.
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