* Italy sells 7 billion euros of debt with ease
* China’s Wen says Merkel allayed some of his fears
* All eyes on ECB and how it will intervene in bond market
* France’s Hollande sees justification for ECB action
By Francesca Landini and Andreas Rinke
MILAN/BEIJING, Aug 30 (Reuters) - A successful Italian bond auction on Thursday pointed to confidence among investors that the European Central Bank will keep its word and take measures dramatic enough to get a grip on the euro zone’s debt crisis.
In Beijing, German Chancellor Angela Merkel appeared to temper China’s fears about the damage the crisis could wreak on the world economy, while French President Francois Hollande, on a visit to Madrid, said he could see a case for ECB intervention.
Since ECB President Mario Draghi vowed a month ago to do whatever it takes to save the euro, Spanish and Italian bond yields have fallen markedly, particularly for shorter-dated maturities. Now he has to follow through.
At a policy meeting next week, Draghi is expected to reveal the ECB’s terms of engagement for intervening in the bond market, reconciling an unwilling German Bundesbank to the plan while avoiding conditions that will scupper its effectiveness.
Credible ECB action to lower Italian and Spanish borrowing costs would buy the two countries time to reduce their debt and push through economic reforms to boost growth potential.
Italy sold 7.29 billion euros ($9.12 billion) of debt at its first auction in a month, and shifted the maximum targeted amount of a new 10-year bond at a yield well under its 6 percent pain threshold.
“It’s a lower yield than the previous one,” said Elisabeth Afseth, fixed-income analyst at Investec in London. “I think it is very much to do with the ECB, and if we hadn’t had that, I suspect that both Spanish and Italian yields would have been considerably wider than where they are.”
Chinese Premier Wen Jiabao said a briefing by Merkel had assuaged his concerns slightly, but no quick resolution of the crisis was in sight.
“The main worries are two-fold: first is whether Greece will leave the euro zone. The second is whether Italy and Spain will take comprehensive rescue measures,” Wen said.
“After I heard her views, it increased my confidence. But I must honestly say, the implementation of these measures won’t be completely smooth,” he said, before adding that China could be prepared to buy more EU government bonds after evaluating the prevailing risks.
His remarks helped lift the euro, although Beijing has made noises about bond buying before with little result.
Draghi has said the ECB will buy Spanish and Italian bonds if called upon but that any recipient country must first seek help from the euro zone’s rescue fund, to which conditions will be attached.
Merkel has signalled her backing for his strategy despite warnings from Bundesbank chief Jens Weidmann that to do so would risk letting indebted euro zone governments off the hook for the austerity measures and reforms they need to implement.
Sources say Weidmann is short of allies within the ECB and could not block the scheme, but if his concerns are not met, ongoing Bundesbank criticism could undermine it.
Draghi has cancelled a visit to a gathering of top central bankers in Jackson Hole, Wyoming, suggesting he has his hands full knocking up a viable plan.
He said on Wednesday the ECB must employ “exceptional measures” at times to fulfil its mandate, his argument being that official euro zone interest rates are at record lows yet borrowing costs in some of its members are sky high, so monetary policy is not working as it should.
Hollande threw his support behind Draghi. “When you see such wide gaps in yields, that could be a justification for an intervention in the name of monetary policy,” he told a news conference after meeting Spanish Prime Minister Mariano Rajoy in Madrid.
A Reuters poll of fund managers showed global investors edged towards more risky assets in August, encouraged by ECB plans to tackle the euro zone crisis.
While an overwhelming 95 percent of fund managers believe that the ECB will buy Spanish or Italian bonds by the end of the year, just over half said Draghi’s announcements did not change their view of the euro zone crisis.
September is shaping up to be a crunch month, with the ECB policy meeting on Sept. 6, followed by a German court ruling on Sept. 12 on whether the bloc’s permanent ESM rescue fund is compatible with Germany’s constitution, and a meeting of EU finance ministers two days after that, at which further aid for Spain is expected to be discussed.
A make-or-break report from EU/IMF/ECB inspectors on the state of Greece’s finances and whether it can meet its bailout targets is due in late September or early October.
The ECB is unlikely to intervene at least until it knows the ESM is operational, sources say.
EU sources have told Reuters Athens is way off meeting its debt targets, leaving a stark choice between giving it more time and money or allowing it to slide into default, with all the contagion threat that would pose to Spain and Italy.
Hollande said European leaders should show support for Greece at an Oct. 19 EU summit if the country’s conservative government shows commitment to move ahead with economic reforms.
Spain remains at the sharp end of the crisis, having switched tack to signal it could seek some form of sovereign bailout. If it sought help from the euro zone’s rescue funds to lower its borrowing costs, the ECB would be expected to pile in behind.
Rajoy has said he will not ask for any further help, to add to a bailout of Spanish banks worth up to 100 billion euros, until the ECB’s strategy is clear.
But with Spain’s important northeastern region of Catalonia calling for government help this week and recession deepening, some form of outside assistance is increasingly likely.
At a joint news conference with Hollande, Rajoy said he would try to avoid raising taxes in next year’s budget although he will have to take tough action to lower the budget deficit.