Germany, France pledge unity as markets falter

NEW YORK/PARIS (Reuters) - France and Germany pledged on Thursday to work together to solve a European debt crisis and support the euro, patching up a public rift that had rattled markets around the world.

The unity pledge came as Germany's parliament prepared to vote on Friday on approval of the country's share of a 750 billion euro rescue for euro zone countries in financial trouble.

The United States edged closer to the most comprehensive overhaul of Wall Street rules since the 1930s after a financial reform bill cleared a procedural hurdle in the Senate, opening the way for a final vote.

France and Germany, co-founders of the euro, had clashed over a unilateral German ban on some speculative trades that on Wednesday spooked markets and sent the currency to a four-year low beneath $1.22.

But the euro rebounded sharply above $1.25 on Thursday, and a German spokesman said Chancellor Angela Merkel and French President Nicolas Sarkozy had agreed to cooperate on euro-zone growth strategies and coordinate their positions on world financial rules at a G20 summit next month.

Germany and France have long been at odds over how to handle Greece's debt crisis, and their unity pledge did not prevent U.S. and European stocks from falling or oil from hitting an eight-month low. Markets also worried that deep spending cuts and tax hikes would slow European growth and possibly derail a fledgling global recovery.

In Washington, U.S. Federal Reserve Governor Daniel Tarullo warned that failure to contain Europe's problems could freeze markets and launch a replay of the 2008 financial market meltdown.

China also said the crisis was adding to uncertainty, as underlined by weakness in its own stock market.

"The euro for now is a secondary story. The danger is that people are doubting the sustainability of the global recovery," said Boris Schlossberg, director of research at GFT Forex in New York. "It's bigger than the euro because everything is so intrinsically woven together."

Earlier, Sarkozy said France would enshrine in its constitution a commitment to cut the country's budget deficit. a move aimed at reassuring markets and placating Berlin.

"This reform will oblige each government coming out of an election to engage in a five-year path dealing with the deficit," Sarkozy said.

Though far less constraining than Germany's "debt brake," which would force the federal government to limit the deficit to 0.35 percent of national output by 2016, France's move highlights how the debt crisis is forcing all euro zone countries to cut back on spending and trim their deficits.

Early this month, Greece was forced to adopt steep spending cuts and tax hikes in exchange for a 110 billion euro ($135 billion) bailout from other euro zone governments and the International Monetary Fund.

Last week Spain and Portugal, struggling with high deficits that prompted investors to drive up their borrowing costs, announced new deficit-cutting measures. Italy is planning deficit reduction steps, as well, while France has proclaimed a three-year public spending freeze.

Europe's move toward more budget austerity was welcomed in Washington, with White House spokesman Robert Gibbs stressing that tough measures were required.

U.S. CLOSES IN ON FINANCIAL REFORM

Tough measures also appeared to be on the menu for Wall Street after the U.S. Senate moved a step closer to approving a sweeping rewrite of financial regulations on Thursday.

The Senate voted 60-40 to wrap up debate, and a final vote could come any time between Thursday afternoon and Friday evening.

Financial reform is a top priority for President Barack Obama, and the Senate bill would tighten rules for banks and financial markets to prevent a recurrence of the 2007-2009 crisis.

Even so, it was the other side of the Atlantic that attracted most market attention on Thursday. Some investors worried that other euro zone countries could follow Germany's lead and ban naked short-selling of some bonds and stocks.

Also on Thursday, Greeks staged another 24-hour general strike, the latest protest against austerity measures demanded by the EU and the IMF.[ID:nLDE64I272].

"IRRATIONAL MARKETS"

The euro has lost more than 12 percent against the dollar this year, shedding 7 percent over the last month.

Jean-Claude Juncker, chairman of the forum of euro zone finance ministers, said the weakness was likely due to fears economic growth in the zone would slow.

But he insisted that the markets were acting irrationally.

"There is a certain reluctance to believe the Greeks can overcome the current crisis. I don't think the markets are behaving in a rational way," he told Reuters in Tokyo.

Irrational or not, anxiety was evident in Europe and beyond. Zhu Guangyao, China's assistant finance minister, said Europe's sovereign debt crisis "is a challenge to the stability of the entire international financial market."

Germany said restoring confidence in the euro was its "top priority," demanding tougher regulation and oversight to protect the single currency.

But France, smarting from Germany's failure to consult it on the trading ban, earlier said it did not agree with Merkel's comment that the euro was under threat.

"I absolutely do not think that the euro is in danger," French Economy Minister Christine Lagarde told RTL radio on Thursday. "The euro is a solid and credible currency."

Germany is the main EU donor in the bailout of Greece and a $1 trillion financial safety net being created for other indebted euro zone nations.

The opposition Social Democrats have threatened to abstain from voting for Germany's share of the rescue unless the government supports a push for an international financial transaction tax.

Although Merkel's center-right coalition does not need opposition support to win approval, it wants as much cross-party backing as possible.

(Additional reporting by Holger Hansen and Brian Rohan in Berlin, Emmanuel Jarry and John Irish in Paris, Renee Maltezou in Athens; Writing by Steven C. Johnson in New York and Paul Taylor in Paris; Editing by Kenneth Barry)