ECB backs Italy, Spain, as politicians pledge action (Reuters)

SYDNEY/Paris The European Central Bank stepped in bond markets Monday, a commitment to support the Spain and Italy with the aim of avoiding the financial meltdown in the euro area, while the G7 and G20 offered soothing words to investors shaken by a historical debt rating downgrade of U.S. backing.

Spanish and Italian bond yields fell as dealers said the Bank was expanding its bond-buying program for debt issued by economies third-and fourth-largest block, in the latest effort to stop the sovereign debt crisis in Europe.

"They're doing clip of 20-25 million (USD) and are spread around the market," said a dealer. "We expect to make billions today."

Equity markets that had been in headlong retreat Asia turned positive in Europe as G20 Finance Chiefs and central bankers pledged to take all necessary measures to support the liquidity, growth and financial stability.

"It seems that policymakers globally are swinging into action," said Shane Oliver, head of investment strategy at AMP capital investors, one of the largest managers of Australia.

"A move to begin now to buy Italian bond could be very positive in helping to calm fears of a further escalation of European debt problems," said Oliver, speaking before the ECB has made its move in the markets.

"Speculators will now think twice before selling or cortocircuite Italian and Spanish bond, knowing the ECB will act against them."

Spread of Italian and Spanish bonds for debt sharply reduced German, credit default swaps fell and stocks of Spanish and Italian jumped more than 3 percent. The euro has also extended gains.

Marked a reversal in mood from the fear that had gripped the Asian markets earlier in the day, when similar engages in a G7 statement had failed to calm investors who drove the safe haven of gold to a record $ 1,715 atop an ounce, while the share markets were again coloured red.

Investors also turned their attention to what the Federal Reserve might say at its policy meeting Tuesday, fueling speculations, soon you may need to consider a third round of quantitative easing to resurrect the richest economy in the world.

COUNTING ON THE FED, ECB

After a conference call Sunday night, the ECB welcomed announcements from Italy and Spain of new deficit-cutting measures and economic reforms, as well as a Franco-German Rescue Fund pledge that the eurozone will take responsibility for the purchase of bonds once it is operational, probably in October.

"The Euro to intervene in a very significant markets and respond in a meaningful way and cohesive", a monetary source said.

The Central Bank had been reluctant to step up its purchase of distressed debt, fearing that it would be seen as a blank cheque to Governments spendthrift.

Since the program began in May last year bought just 80 billion of bonds, while Italy and Spain alone question about 600 billion annually. Dealers said that it would take a pledge to buy several hundred billion euros of debt go ahead of fears of contagion.

At the same time the G7-United States, Britain, Canada, France, Germany, Italy and Japan--said it would take joint action in currency markets if needed because "disordered movements ... adversely affect economic and financial stability."

The G20 Communique followed shortly after the opening of European markets.

The Japanese intervened to keep their currency last week, while the National Bank of Switzerland surprised with a new easing cycle as they battled a fast-growing Franco.

Pressure is growing on the Fed now to look for further easing from the market-QE3 voiced – although few expect anything dramatic from policy meeting Tuesday.

"We are probably a bit closer. But I don't think we yet, "said Nomura's global chief economist Paul Sheard. "I believe that the Fed would have to get a little more worried that financial markets were spinning out of control before accepting with QE3".

CHINA NOT HAPPY

None of which was enough to reassure the single largest creditor of Washington, China.

"It must be understood that if the United States, Europe and other advanced economies does not take responsibility and continue their ceaseless joke about selfish interests, this will seriously hinder stable development of the global economy," said a comment the people's daily, the mouthpiece of the Communist Party of China.

China has over one trillion dollars of U.S. Government paper and was not so happy when the debt rating of AA-plus United States to cut & Poor Standard from AAA-a move that infuriated the Treasury Secretary Timothy Geithner.

In an interview to NBC and CNBC television, Geithner said the rating agency "showed really terrible judgment" and claimed the downgrade means nothing and does not affect the faith of investors in debt of the United States.

Japanese Finance Minister Yoshihiko Noda put a face on it on Monday, saying that the market confidence in the dollar and the treasure of the United States has not wavered and indicated for the internationalization of Tokyo to maintain its massive holdings of United States Government.

(Additional reporting by Laura McInnis, David Lawder Washington and Mark Felsenthal, Sarah Marsh in Berlin, Astrid Wendlandt, Yeonhee Kim and Yoo Choonsik in Seoul, Praveen Menon and Shaheen Pasha in Dubai and Reuters offices worldwide; Written by Wayne Cole and Alex Richardson; Editing by Ed Davies and Dean Yates)

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