* ECB chief calls for new euro zone fiscal compact
* Draghi signals stronger crisis action if deal reached
* Sarkozy says to meet Merkel Monday to put treaty proposals
* Germany proposes special fund to pay off excess debt
By John O'Donnell and Emmanuel Jarry
BRUSSELS/TOULON, France, Dec 1 The new
head of the European Central Bank signalled on Thursday it stood
ready to act more aggressively to fight Europe's debt crisis if
political leaders agree next week on much tighter budget
controls in the 17-nation euro zone.
In France, President Nicolas Sarkozy called for a new treaty
incorporating tougher budget discipline, a European Monetary
Fund to support countries in difficulty and decisions in the
euro area taken by majority vote instead of unanimity.
Addressing supporters in the port city of Toulon, Sarkozy
said he and German Chancellor Angela Merkel would meet next
Monday to outline joint proposals to put to a Dec.9 EU summit,
seen as make-or-break for the 12-year-old single currency.
"Let us not hide it, Europe may be swept away by the crisis
if it doesn't get a grip, if it doesn't change," Sarkozy said,
warning that a collapse of the euro would make France's debt
unmanageable and wipe out people's savings.
"We don't have the right to let such a disaster happen."
ECB President Mario Draghi painted a dark picture of the
state of Europe's banking system, speaking a day after the
world's major central banks took emergency joint action to
provide cheaper dollar funding for starved European banks.
"A new fiscal compact would be the most important signal
from euro area governments for embarking on a path of
comprehensive deepening of economic integration. It would also
present a clear trajectory for the future evolution of the euro
area, thus framing expectations," he told the European
Draghi did not spell out what action the ECB might take,
saying only a commitment by political leaders to stricter budget
discipline and binding their economies more closely "is
definitely the most important element to start restoring
credibility. Other elements might follow, but the sequencing
In the short-term, economists expect the central bank to
relieve pressure on banks and an economy heading into recession
by cutting interest rates next week and announcing longer-term
cheap liquidity tenders with easier collateral rules. Markets
are pricing in a 25 basis point cut to 1.0 percent on Dec. 8.
Draghi, who faces some of the toughest decisions in the
currency's 12-year history after just one month in the job, said
the ECB was aware many European banks were in difficulty because
of stress on sovereign bonds, tight inter-bank funding markets
and scarce collateral.
"Downside risks to the economic outlook have increased," he
said, noting that the ECB's mandate was to maintain price
stability "in both directions" -- a rare indication that the
bank is concerned about deflation risks as well as inflation.
Sarkozy voiced similar sentiments in words designed to
reassure voters anxious about handing more power to Brussels. He
called for an "intergovernmental" Europe and made no mention of
the stronger role for the European Commission or the European
Court of Justice sought by Berlin.
"Sovereignty can only be exercised with others. Europe
doesn't mean less sovereignty but more sovereignty because it
gives us a greater capacity to act," Sarkozy declared.
His Socialist opponents in next year's presidential election
denounced an "austerity treaty" imposed by Germany.
Merkel is due to outline her own vision in an address to
parliament in Berlin on Friday. Aides said the leaders conferred
by telephone to ensure that their speeches, while different in
tone, would not be incompatible.
Sarkozy avoided calling directly for massive ECB action to
buy bonds of troubled euro zone states or cut interest rates.
But he said: "Naturally the European Central Bank has a decisive
role to play ... I am convinced that faced with the risk of
deflation with threatens Europe the central bank will act."
Two years into Europe's debt crisis, investors are fleeing
the euro zone bond market, European banks are dumping government
debt, south European banks are bleeding deposits and a recession
looms, fuelling doubts about the survival of the single
The euro and European stocks extended gains
after surging on Wednesday upon the joint dollar liquidity move
by the U.S. Federal Reserve, the ECB and the central banks of
Japan, Britain, Canada and Switzerland.
Markets were cheered by strong demand at Spanish and French
bond auctions on Thursday. France's 10-year bond spread over
safe haven German Bunds fell below 100 basis points for the
first time since Oct. 28 after peaking above 200 bps in
NO MORE LOSSES?
EU paymaster Germany is pressing for limited treaty changes
to establish coercive powers to veto national budgets in the
euro zone that breach agreed rules.
Berlin wants the European Commission to be empowered to
reject national budgets before they go to parliament and to
refer serial deficit offenders to the European Court of Justice.
Sources close to the negotiations said Germany and France
had yet to agree on key issues including the role of the EU
executive and court, with Paris preferring an intergovernmental
approach leaving the final word with elected leaders.
In another apparent difference, Sarkozy called for a
guarantee that savers would face no further losses on European
sovereign bonds, and that writedowns for private creditors of
Greece would be a one-time exception.
Berlin and its north European allies have so far insisted
that private investors must accept the risk of a so-called
"haircut" on government bonds issued from 2013.
The conservative Sarkozy's main challenger in next year's
presidential election, Socialist Francois Hollande, said on
Wednesday that as president he would never hand France's budget
sovereignty over to European judges.
German Finance Minister Wolfgang Schaeuble said he would
propose at the summit that EU states set aside sovereign debt of
over 60 percent of gross domestic product -- the EU treaty limit
-- in special funds to be paid off over 20 years with national
Leaders of Merkel's centre-right coalition agreed that
Germany's opposition to common euro zone debt issuance was
non-negotiable, slamming one door which France and other
southern euro zone states have tried to open.
With the ECB barred by treaty from acting as lender of last
resort to the euro zone or directly financing governments, EU
officials are working on ways to support states under bond
market pressure, possibly via the International Monetary Fund.
One idea under active consideration is allowing euro zone
national central banks affiliated to the ECB to lend money to
the IMF which could provide larger credit lines for Italy and
Spain on strictly monitored policy conditions.
In Greece, where the euro zone debt crisis began in 2009,
schools, hospitals and public transport were paralysed by a
one-day general strike in protest at the new national unity
government's EU/IMF-imposed "starvation" budget.
The strike is the first such test for new technocrat Prime
Minister Lucas Papademos, who has had little time to celebrate
since European finance ministers this week approved an 8 billion
euro tranche of aid to prevent Greece from going bankrupt.