ECB Move Hits Greek Assets -- 7th Update

By Josie Cox 

Greek stocks and bonds took a beating Thursday after the European Central Bank fueled an increasingly tense standoff between the Greek government and its international creditors.

Athens' main stock index fell by as much as 9%in early trade before ending the session 3.4% lower, while yields on Greek government bonds soared, indicating that investors see a swelling risk of default.

The sharp moves came after the ECB said Wednesday evening that it would stop accepting Greek bonds as collateral for central bank loans.

Losses were particularly hefty in the banking sector, where shares in Piraeus Bank SA, National Bank of Greece SA, Alpha Bank AE and Eurobank Ergasias SA fell by as much as 27% in early trade, before paring losses and closing between 10% and 15% lower.

"It is currently not possible to assume a successful conclusion" of Greece's current bailout, the ECB said late Wednesday, just hours after its president, Mario Draghi, met with Greece's new finance minister, Yanis Varoufakis in Frankfurt.

Wednesday's announcement marked the first time since 2012--when Athens was locked in another round of acrimonious negotiations with its creditors--that the central bank has suspended its waiver for Greece's junk-rated bonds.

In a further attempt to break the deadlock, Mr. Varoufakis met German finance minister Wolfgang Schäuble Thursday in Berlin. Mr. Varoufakis said Greece would do everything in its power to avoid default, and proposed a bridging program to negotiate new debt terms. Mr. Schäuble said the causes of Greece's pain lay in Greece, not in the rest of Europe, and that overhauls were unavoidable.

"No solution can now be swift or clean," said Nick Lawson, a senior trader at Deutsche Bank, while Gary Jenkins, head credit strategist at London-based asset manager LNG Capital termed the ECB's move 'aggressive'.

"Whilst the most likely outcome is for some kind of compromise, there still remains the possibility that Greece could end up defaulting and exiting the eurozone, almost by accident as much as design," he said.

Salman Ahmed, global fixed-income strategist at Lombard Odier Investment Managers, which has total assets under management of 156 billion Swiss francs ($168 billion), said the move shows the ECB is clearly playing hardball.

He said it was important to note that Greece hasn't completely lost access to funding--it can still use emergency liquidity assistance, or ELA. However, "if the ECB decides to put a cap on the ELA, then Greece will have a real problem, and this could lead to 'Grexit'."

That heightened perceived risk of default saw the yield on the country's two-year debt soar by more than three percentage points to well above 19% before retreating somewhat. The yield on Greece's five- and 10-year debt also climbed sharply on the day, but recovered to trade around 13.2% and 9.7%, respectively at the European market close.

Short-term yields rising above those on longer-dated bonds is often a sign that investors are worried about the risk of default. Yields rise as bond prices fall.

"Since the beginning of the eurozone crisis, the ECB has again and again tried to pass the onus of responsibility for turning the structural corner to national governments," said Anthony Peters, a strategist at capital markets adviser SwissInvest.

"Letting [national governments] use cheap ECB funding as a means of postponing reforms wasn't its intention [and] it has finally made good and has quite publicly returned its wallet into its back pocket," he added.

Germany's DAX and France's CAC ended Thursday 0.1% lower and 0.2% higher respectively, while London's FTSE 100 index added 0.1.

The pan-European banking subindex fell around more than 1% while the VStoxx Index, a gauge of volatility on the euro Stoxx 50 Index, rose almost 1% on the day.

In currency markets, the euro tumbled more than 1% close to a fresh 11-year low immediately after the ECB's announcement on Wednesday, but managed to claw back the majority of that on Thursday. One euro currently buys $1.142.

Frederik Ducrozet, a senior economist at Crédit Agricole, said the ECB had resorted to a "risky, albeit calculated political move."

"It is bad news in the sense that it goes against Greece's proposal to buy time in the negotiation process. In the end, the decision to pull funding has to be a political one, so even in the extreme case where there is no agreement by early March, we find it hard to imagine the ECB intentionally triggering a bank run," he added.

Simon Derrick, chief market strategist at BNY Mellon said in the first instance the move sends a very clear signal to the Greek government rather than anything else: "There is little room for compromise in the coming negotiations."

Write to Josie Cox at [e-mail]

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