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Europe's sovereign debt crisis is the financial world's nightmare of the moment, but there is some good news.

The intensity of the crisis appears to be ebbing, according to DBRS Ltd., a Toronto-based bond rater that is Canada's answer to the better known international credit evaluators, Moody's and Standard & Poor's, which made headlines last week by kicking France out of the triple-A club.

The cause of DBRS's more optimistic stance: The European Central Bank is acting more forcefully to make sure the continent's troubled banking system doesn't implode, a sign policy makers are beginning to take the steps needed to avoid a dire outcome.

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In late December, the central bank pumped a massive €489-billion ($641-billion) into Europe's liquidity-starved commercial banks, stabilizing the financial system at a time when it was teetering on the edge of a panic. Under its program, known formally as longer-term refinancing operations, or LTROs, banks can borrow for three-years from the ECB at the rock-bottom interest rate of 1 per cent.

The central bank's move "greatly reduces uncertainty over bank funding which has been one of the main risks in Europe over the last six month," says Fergus McCormick, the New York-based head of sovereign ratings for DBRS.

He says the liquidity injection shows Europe is getting serious about solving its economic crisis. The injection is a backdoor form of money printing because it allows the European Central Bank to expand its balance sheet, the first step in the creation of new money, a helpful elixir in all times of financial stress.

The lending program is "the clearest evidence yet that a pan-euro area institution is willing to provide a massive amount of liquidity to support the whole of the euro area and we view this as a very important signal of political support for the single currency," Mr. McCormick said.

By looking at interest-rate spreads, DBRS believes that some of the new money from the ECB has flowed into European government debt with less than three-year maturities, helping to stabilize the sovereign debt market.

Mr. McCormick says there is only a small risk any country will leave the euro, terming it a "very, very outside chance." It's a position that puts the firm at odds with other market watchers, such as Capital Economics, a well-regarded economic consulting firm, that says it's pretty sure at least one nation will exit the monetary union in 2012, possibly in a disorderly way.

To be sure, DBRS still sees problems. It has a negative outlook on the government ratings of five countries – Italy, Spain, Ireland, Portugal and Belgium. The countries face various risks, such as having to roll over large amounts of existing debt and poor economic growth.

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Meanwhile, banks, which have helped themselves to piles of fresh ECB cash, are hoarding the money, and haven't begun to lend it, a situation that has left companies and individuals in the zone starved for credit.

Mr. McCormick said that, despite the important signs of progress he's seeing, there remain "very significant downside risks."

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About the Author
Investment Reporter

Martin Mittelstaedt has had a varied reporting career at the Globe and Mail, covering politics, the environment and business. He opened up the Globe's New York bureau for the Report on Business, and has also been on the banking and capital markets beats. He's written extensively on investing themes. More

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