By Noah Barkin and Terhi Kinnunen
BERLIN/HELSINKI (Reuters) - European leaders must deliver a convincing response to the euro zone's debt crisis regardless of a European Central Bank threat to raise interest rates, German Chancellor Angela Merkel said on Friday.
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She was speaking a day after ECB President Jean-Claude Trichet shocked markets by saying the central bank may increase rates as early as April due to inflation risks.
"Regardless of the question of the ECB and interest rates, we know that we need to put a joint package for the euro zone on the table," she told a joint news conference.
She stressed Germany's priorities to strengthen fiscal discipline and boost economic competitiveness in the 17-nation single currency area, but did not rule out letting the euro zone's temporary rescue fund buy government bonds.
Finnish Finance Minister Jyrki Katainen, speaking before hosting a meeting of center-right European leaders including Merkel in Helsinki on Friday evening, said the rescue fund's effective lending capacity should be increased to the full 440 billion euros, even though it was not clear any other country needed to tap the fund at this stage.
But he said the European Union should not loosen conditions on rescue loans for Ireland, as the country's prime minister in waiting has requested, saying there were "no free lunches."
Asked about letting the European Financial Stability Facility purchase bonds of vulnerable members states, Merkel said: "There is a lot of discussion going on about possible options and these need to be examined."
Her center-right parliamentary coalition parties and the Bundesbank have publicly opposed allowing the EFSF to buy bonds or lend money to fund debt buy-backs by states in difficulty.
EU diplomats say Germany is waiting to see what commitments other countries are prepared to give at a March 11 euro zone summit before showing its hand on the rescue fund and whether to allows its full 440 billion euros to be lent out.
Analysts said the ECB move raised pressure on EU leaders to agree on decisive action at this month's summits.
Failure would risk a fresh market attack, probably first against Portugal which is seen as the likeliest candidate to follow Greece and Ireland in needing a bailout.
The ECB did agree to keep offering banks unlimited liquidity until mid-year, something Portuguese banks have relied upon.
Prime Minister George Papandreou of Greece, the first country to require a euro zone bailout, warned EU leaders of a bond market backlash against the euro zone if they fail to take bold decisions at this month's summits.
"Only a coordinated policy can calm the markets," Papandreou said in a speech to his Socialist party's national council.
"If our decisions in the EU are not brave and effective, markets will react very quickly and we will find ourselves at the negotiating table again."
European Monetary Affairs Commissioner Olli Rehn also cautioned that a successful outcome to the sovereign debt crisis "is by no means guaranteed."
Speaking at a Bank of France conference in Paris, Rehn said EU fiscal reforms must ensure sanctions for "irresponsible behavior" were more automatic and less subject to political deliberation.
He thanked the ECB for its support for stricter enforcement of the rules. France and Germany have led euro zone states in watering down the Commission's proposals by requiring an extra vote by finance ministers before sanctions are applied.
Trichet said on Thursday the EU needed much tighter controls on public finances and encouraged the European Parliament, which much approve the new rules, to insist on a firmer stance.
IRELAND TO SEEK CHEAPER LOANS
Irish prime minister-in-waiting Enda Kenny was set to plead for easier bailout loan terms to Merkel and other center-right European leaders in Helsinki on Friday evening. The dozen leaders will discuss the interest rate on emergency lending to Ireland and other debt issues.
The meeting will take no formal decisions but is expected to shape thinking on the overall effort to contain the debt crisis.
Merkel was cool on Wednesday to the incoming Irish leader's demands for a renegotiation of the terms of an 85 billion euro financial rescue agreed last November, saying the agreement was only recent and interest rates could not be cut artificially.
Greece and Ireland are struggling with the same dilemma. Punitive interest rates imposed by the euro zone are higher than their projected economic growth rates, making it harder for them to service their growing debt burden in future.
In a possible hint of German flexibility, a senior lawmaker in Merkel's Christian Democratic (CDU) party said Germany might be willing to support a cut in the cost of the Irish rescue package if Dublin raised its low corporate tax rate.
"A small rise in Ireland's lower than average corporate tax rate" might help lower the country's risk profile and form the basis for a possible renegotiation, Michael Meister, the CDU's deputy parliamentary floor leader, told Reuters in Dublin.
Another point of discussion in Helsinki was likely to be a German-French initiative for a "competitiveness pact" across the euro zone, including measures to put legal limits on deficits, encourage the gradual raising of retirement ages and work toward a common corporate tax base.
The German and French plan raised hackles among euro zone member states when it was put on the table in early February, but a re-worked version drafted by Van Rompuy after wide consultations has gained more broad-based support.
(additional reporting by George Georgiopoulos in Athens, Daniel Flynn and Leigh Thomas in Paris, Andreas Rinke in Helsinki, Sarah Marsh in Berlin; writing by Paul Taylor and Luke Baker, editing by Mike Peacock)