EU to decide on firewall in March, ECB says clock ticking

BRUSSELS Fri Mar 2, 2012 9:29am EST

European Council President Herman Van Rompuy holds a news conference at the end of a European Union leaders summit in Brussels March 2, 2012. REUTERS/Sebastien Pirlet

European Council President Herman Van Rompuy holds a news conference at the end of a European Union leaders summit in Brussels March 2, 2012.

Credit: Reuters/Sebastien Pirlet

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BRUSSELS (Reuters) - The euro zone will decide whether to increase its debt crisis firewall before the end of March after the European Central Bank said its extraordinary support measures would not be repeated, putting the onus squarely back on governments to act.

Speaking after a two-day summit of EU leaders, Herman Van Rompuy, the president of the European Council, said euro zone finance ministers would meet to discuss the size of a permanent rescue fund, probably at an informal gathering in Copenhagen set for March 30-31.

The aim will be to combine the 250 billion euros left in the temporary EFSF bailout fund with 500 billion euros in the permanent ESM facility to create a "super-fund" better able to cope with potential problems in Spain or Italy, although Germany remains opposed to the idea for now.

"We will revaluate the ceiling for the ESM and EFSF during the month of March," Van Rompuy said, adding that countries would pay two tranches of capital into the ESM this year, ensuring that a strong facility is running from July.

French President Nicolas Sarkozy said he and German Chancellor Angela Merkel had agreed to resolve the firewall "by the end of March," reiterating the deadline.

The stepped-up commitment followed a firm message from ECB President Mario Draghi at a dinner late on Thursday, during which he warned the EU's 27 leaders against complacency, after several had suggested the worst of the crisis may be over.

"It was a subdued message," said one euro zone diplomat briefed on Draghi's intervention. "He said there were timid signs of stabilization but emphasized that the overall situation was fragile."

Speaking after the summit, Merkel made clear the crisis, which began in 2010, was far from over.

"We are still in a fragile situation. The situation is somewhat calmer but the crisis has not at all been overcome. Further steps are necessary," she said.

Officials said Draghi had told the leaders that the central bank's provision of more than 1 trillion euros of cheap three-year loans was not going to be repeated. It had merely brought the euro zone time, he said, and made it essential that structural reforms were pushed through promptly.

"We will use this time," said Merkel. "We will certainly not take such additional measures. The liquidity goes out of the market again."

The ECB has delivered two injections of capital in three months - 489 billion euros in December and 530 billion on February 29, equivalent to nearly 10 percent of euro zone output.

"We've got three years to reform, otherwise things are going to get very complicated," said one euro zone diplomat.

Merkel faces strong public hostility to further bailouts and a backbench revolt in her centre-right coalition that could make it hard to win parliamentary support for a bigger bailout fund.

Major economies in the Group of 20 told the Europeans last weekend they would not give the International Monetary Fund more money to combat the fallout from the euro zone crisis unless Europe first increased its own warchest.

SPAIN CONCERNS

The March 1-2 summit is the first for more than 18 months that has not focused almost entirely on crisis resolution, with leaders instead looking to shift the narrative towards growth as recession looms and unemployment climbs steadily.

But underpinning the discussions about how to stimulate the economy were concerns about the austerity drive having gone too far, with countries too battened down to grow.

Spain, where the economy is forecast to shrink at least 1.0 percent this year, defied the European Union, setting a 2012 deficit target at 5.8 percent of gross domestic product, a far softer goal than the 4.4 percent agreed with Brussels.

Prime Minister Mariano Rajoy had hoped to get backing for some leeway, explaining that it was putting Madrid in a straightjacket while unemployment stands at 23 percent and rising and growth is evaporating.

But in the event the leaders made clear countries were expected to meet their budget deficit goals, underlining that new rules imposed over the past two years were not going to be loosened just because one or two were facing difficulties.

"For the credibility of our operation we must maintain the budgetary objectives and if we don't do that in a consistent way, then the financial markets will punish us," Van Rompuy said. "What you think you will get from weakening the budgetary measures you will lose in increases in interest rates."

It remains to be seen what steps the European Commission may take against Spain for missing the 2012 deficit target.

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Euro zone crisis in graphics r.reuters.com/hyb65p

Interactive crisis timeline link.reuters.com/qew66s

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CLOCK TICKING

While the ECB program, introduced shortly after Draghi took over as president in November, has done much to calm financial markets, the Italian has come under pressure internally over the strategy.

Bundesbank chief Jens Weidmann wrote to Draghi last month to express concerns about risks stemming from the strategy and other ECB policymakers have similar qualms, saying it could fuel imbalances in the euro area and stoke inflation.

Sources had told Reuters last month the second round of funding was likely to be the last, with liquidity equivalent to nearly 10 percent of euro zone GDP injected into the economy in less than three months.

For Draghi, the message is now that euro zone leaders have to implement the strict structural economic reforms demanded by their peers, including to rigid labor markets and costly pensions systems, so they are prepared for the future.

Irish Prime Minister Enda Kenny, whose country has already received a bailout from the EU/IMF but is doing better than either Greece or Portugal at handling the demands imposed upon it, said there was no scope to slacken on reforms.

"We've come to a new place but Europe still has a long way to go," he told reporters after the summit. "There's not a sense of complacency about this at all."

(Additional reporting by John O'Donnell, Jan Strupczewski, Paul Taylor, Ilona Wissenbach and Julien Toyer; writing by Luke Baker, editing by Mike Peacock)

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