News

EU leaders go into a Brussels meeting on Thursday more openly divided than at any time since the euro crisis began, with Germany's Chancellor Angela Merkel showing no sign of relenting in her refusal to back other countries' debts.

Merkel is being urged at home to stay tough and reject all efforts to make Germany underwrite European partners' debts or banks, while her EU partners say that may be the only way to save the single currency.

"Nein! No! Non!" shouted a headline splashed across the front page of the normally sober German business daily Handelsblatt, with a commentary by its editor-in-chief saying Merkel must remain firm at the two-day summit.

Spain and Italy, the latest euro zone countries in financial markets' firing line, are pleading for emergency action to bring down their spiralling borrowing costs before they are forced out of the bond market. They want the euro zone's rescue funds or the European Central Bank to intervene fast.

A senior German government source, briefing reporters in Berlin before the summit, due to start at 1300 GMT, played down the leap in Spanish and Italian borrowing costs. "We would warn against exaggerated panic-making," he said.

European Council President Herman Van Rompuy and European Commission President Jose Manuel Barroso proposed in a report this week creating a euro zone treasury to issue joint bonds in the medium-term, and establishing a European banking union with central supervision, a joint deposit guarantee and a resolution fund.

Merkel insists that fundamental reforms to give European Union authorities power to override national budget and economic policies must come before any further shared liability.

"Now she must explain to our friends at the summit that it would help no one if Germany lavishly handed out the fruit of its labour. It is even the other way around: 'yes' to Europe means 'no' to Barroso's ideas," Handelsblatt's Gabor Steingart wrote.

His comment reflected widespread public views in Germany, which has enjoyed an export boom while Greece, Ireland and Portugal and now Spain and Cyprus have needed bailouts. The economic crisis is only just starting to pinch in Germany, where growth is slowing and unemployment crept up unseasonally in June.

Hans-Werner Sinn, head of the Ifo economic research institute and a leading Eurosceptic, said in a working paper: "Had we known 20 years ago what difficulties the euro zone would be mired in today, and what pressures we would face, Germany would never in its life have agreed to the euro, at least not with all those who are members today."

Turmoil

The meeting is the 20th summit of leaders of the 27 EU states since the crisis erupted in early 2010, giving them a reputation for failing to match their talk with the sort of decisive action needed to resolve it.

Many international investors have deserted Spanish and Italian debt, pushing yields to levels that Madrid at least cannot afford for long as it tries to save banks ravaged by a
property market collapse and cut its spiralling budget deficit.

European Economic and Monetary Affairs Commissioner Olli Rehn said the summit would work on unspecified "short-term measures" to stabilise markets. Merkel has brushed aside demands from Rome and Madrid for rapid measures to support their bonds.

French President Francois Hollande is championing joint "eurobonds" to bring down borrowing costs for the weaker euro zone countries as the pool of guarantors would include the strongest - meaning Germany.

But Germany does not want to use its credit rating to support other members unless they first agree to share control of taxing and spending powers.

Hollande and Merkel held talks in Paris on Wednesday evening to try to narrow their differences. In a brief statement before their meeting, Merkel told reporters: "I say we need more Europe and I think we are in agreement there.

"We need a Europe that functions effectively, markets are looking for this, and a Europe where countries help each other."

Austrian Chancellor Werner Faymann said the 17-nation currency bloc's permanent rescue fund, the European Stability Mechanism (ESM), due to start operating next month, should be turned into a bank and allowed to borrow from the ECB, which could quadruple its 500 billion euro ($625 billion) warchest.

"We need a banking licence for the ESM, a debt reduction fund, strict rules for banks with more intervention rights for supervision," he told Austria's Kleine Zeitung daily.

That backed proposals by Italian Prime Minister Mario Monti to leverage up the rescue funds to underpin troubled countries' bonds.

But the senior German government source said the EU already had instruments at its disposal to handle all crisis scenarios, and Germany was sceptical about developing yet another tool to solve Italy's problem.

Speaking in parliament on Wednesday, Merkel said she considered joint euro bonds and bank deposit guarantees illegal, economically wrong and politically counterproductive. Even Europe's strongest economy must not be overburdened, she said.

"Joint liability can only happen when sufficient controls are in place," she said. The remarks appeared to be a less definitive rejection of common euro zone bonds than she made behind closed doors on Tuesday, when she said she did not expect to see shared debt liability in her lifetime.

Rehn said leaders would work at the summit on steps to relieve market pressure on countries at risk. "We are working with euro area member states in order to enable convincing decisions for the short-term stabilisation of the financial markets, especially bond markets of euro area member states under particular market pressure," he said.

Rajoy's plea

Spanish Prime Minister Mariano Rajoy said he would ask other EU leaders to allow the bloc's bailout funds or the European Central Bank to stabilise financial markets.

Rajoy warned that Spain could not live indefinitely with yields on its 10-year bonds near seven percent. "The most urgent issue is the one of financing. We can't keep funding ourselves for a long time at the prices we're currently funding ourselves," he told parliament.

Spain is one of five euro zone countries - more than a quarter of the total - to request euro zone bailout funds as it needs up to 100 billion euros to recapitalise its banks.

Madrid won time on Wednesday to negotiate the terms of the bank aid when it gained approval for a state liquidity guarantee of 19 billion euros for Bankia, the country's biggest problem lender.

Spain has been seeking a temporary mechanism to fund four nationalised banks that urgently need money, since it could take three to four months for the European aid to reach the country's financial system.

Cyprus won support from its euro zone partners for emergency funding to prop up its banks, crippled by their Greek debt holdings, in assistance which will probably include aid from the IMF.