Europe's Leaders Unusually Divided Before Summit

Published June 27, 2012

| Reuters

European leaders sound c before a high-stakes summit, with Germany's Angela Merkel saying total debt liability would not be shared in her lifetime and giving little support to Italian and Spanish pleas for immediate crisis action.

Rome and Madrid have seen their borrowing costs spiral to a level which for Spain at least would not be sustainable as it battles to recapitalise banks ravaged by a burst property bubble and cut a towering government deficit.

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

Speaking in parliament before a meeting of European heads in Brussels on Thursday and Friday, Rajoy warned that Spain would not be able to finance itself indefinitely with 10-year bond yields 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.

Even when there are profound disagreements, EU leaders have been burned by the markets enough times to generally make sure they sound united before major gatherings.

But divisions have been exposed by the ousting of Nicolas Sarkozy by socialist Francois Hollande as French president and the fact that Rome and Madrid have muscled into the traditional Franco-German axis.

The leaders held an unusually discordant news conference in Rome on Friday. Hollande said there must be more solidarity in Europe before countries hand over more sovereignty over their national budgets, while Merkel said she would not accept extra liabilities without overarching budget control.

The pair will have a working dinner in Paris on Thursday evening, an opportunity to repair the damage. An initial attempt to smooth over differences came at a meeting of the four countries' finance ministers late on Tuesday after which nothing was said.

In Rome, Italian Prime Minister Mario Monti said he would not simply rubber stamp conclusions at the EU summit and said he was ready to go on negotiating into Sunday evening if necessary to agree on measures to calm markets.

With Hollande's support, Monti is pushing for the euro zone's rescue funds to be used to help limit the spreads over German Bunds on bonds issued by countries that respect EU budget rules. Rajoy would settle for that or the European Central Bank doing the same job by reviving its bond-buying programme.

The proposal has run into stiff opposition from Germany, the largest economy in the European Union and the bloc's effective paymaster, and has been rejected by Jens Weidmann, the powerful head of the German central bank, the Bundesbank.

Stock markets perked up last week on the hope that the 20th EU summit since the bloc's debt crisis exploded into the open in Greece would come up with dramatic measures. Investors have since thought better of that view.

European shares edged up on Wednesday and the euro was flat, with many investors out of the markets before the Brussels meeting.

"People are waiting for the inevitable - which is that policymakers will probably fail to do what is necessary," said Neil Mellor, currency analyst at Bank of New York Mellon.

BORROWING COSTS

Merkel stomped on the idea of mutualising debt - favoured by France, Italy and Spain - at a meeting of lawmakers from her Free Democratic coalition partners in Berlin on Tuesday, according to people who attended the closed-door session.

"I don't see total debt liability as long as I live," she was quoted as saying, a day after branding the idea of euro bonds "economically wrong and counterproductive".

The words may have been carefully chosen and do not at face value rule out mutualising some portion of euro zone members' debts as the end point of a drive towards fiscal union.

Merkel find herself in a dwindling minority but holds the euro zone's purse strings and therefore nearly all the cards.

German opposition SPD leader Sigmar Gabriel told the Financial Times that urgent measures were needed to lower euro zone sovereign borrowing costs otherwise the currency bloc could "simply explode".

Italy and Spain argue that they are stretching every sinew to cut their debt mountains and need some support from their currency area peers to keep the markets at bay.

Monti won the first two of four confidence votes on Tuesday called to accelerate the passage of his labour reform that has been criticised by both by labour unions and the business establishment. The final two votes, and definitive approval, are due on Wednesday.

Spain, which has been offered loans of up to 100 billion euros to recapitalise its banks but which is determined not to ask for a sovereign bailout, is considering raising consumer, energy and property taxes.

Spanish Economy Minister Luis de Guindos said he had talked with the finance ministers of Germany, France and Italy already on Wednesday with further discussions planned.

Euro zone finance ministers will also hold a conference call on the bailout of Spanish banks and this week's request for aid from Cyprus, EU officials said. The request made Cyprus the fifth of the euro zone's 17 states to seek aid from EU rescue funds, after Greece, Ireland, Portugal and Spain.

Underlining the parlous state of Spanish finances, figures showed the central government's deficit had already reached 3.41 percent of annual gross domestic product through just the first five months of the year, close to its target for the whole year of 3.5 percent.

Spain's central bank said on Wednesday it expected recession to deepen in the second quarter of the year.

The Brussels summit is expected to agree on a growth package pushed by France worth around 130 billion euros ($162 billion) in infrastructure project bonds, reallocated regional aid funds and European Investment Bank loans.

Leaders will also discuss proposals for a banking union, but while they are likely to agree to give the ECB power to supervise big cross-border banks, Merkel is resisting any joint deposit guarantee or common bank resolution fund. (Writing by Mike Peacock; Editing by Peter Graff)

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