* EU leaders divided on crisis response
* Italy, Spain hold up growth package to demand urgent
* Focus on using EU rescue funds to buy Spain, Italy
* Merkel says budget control must come before debt sharing
By Luke Baker and Catherine Bremer
BRUSSELS, June 28 Italy and Spain, battling
searing market pressure in the euro zone's widening debt crisis,
blocked agreement on measures to promote growth at a European
Union summit on Thursday to demand urgent action to bring down
their borrowing costs.
Italian Prime Minister Mario Monti and his Spanish
counterpart, Mariano Rajoy, refused to sign off on a 120 billion
euro ($149 billion) growth package until EU paymaster Germany
approved short-term measures to ease their cost of credit.
The clash highlighted tensions between northern creditor
countries and heavily indebted southern states over the future
shape of the troubled 17-nation currency bloc, now in the third
year of a sovereign debt crisis.
Hours later than planned, European Council President Herman
Van Rompuy came out to announce a deal in principle on measures
to stimulate infrastructure investment and give more capital to
the EU's soft-lending arm, the European Investment Bank.
"There's no blockage, we keep on working and we move on," he
told a belated news conference, playing down the row.
However, French President Francois Hollande confirmed that
Italy and Spain had withheld approval of the growth pact until
euro zone leaders agree short-term measures to stabilise
markets, but said he expected a deal on Friday.
"Everyone must make an effort so that markets are convinced
that the measures are effective, and they must be," Hollande
told a news conference. "We all need Italy and Spain to have
lower interest rates today and for Spain's banks to be
recapitalised because that will bring relief for the euro zone."
Senior finance officials, meeting during the summit,
proposed setting up a single supervisory authority for euro zone
banks involving the European Central Bank, and letting the
bloc's rescue fund recapitalise banks directly, subject to
conditions, a document obtained by Reuters said.
The document, to be put to leaders, said the temporary EFSF
rescue fund and its permanent successor the ESM would be used
"in a flexible and efficient manner" to stabilise markets.
Rome and Madrid want to see steps to allow the rescue funds
to buy their government bonds and lend money directly to
recapitalise Spanish banks without adding to the public deficit.
"There's an epic battle going on between those who seek
immediate and unconditional solidarity and those who seek to
fundamentally change the way European economies are run and put
Europe on a course of stability, discipline and growth," one EU
official said after nearly eight hours of debate.
Merkel cancelled a news briefing as the argument dragged on
through the evening. The summit agenda was upended to enable
euro zone leaders to hold a post-midnight discussion on the
future of their troubled 17-member currency union.
It was the 20th EU summit since the sovereign debt crisis
began in early 2010 after Greece disclosed its public deficit
was far higher than previously reported.
Policymakers played down any prospect of a definitive
solution to the turmoil that has forced Greece, Ireland,
Portugal and now Spain and Cyprus to seek international
As the leaders argued, Italy beat Germany 2-1 in the Euro
2012 soccer semi-final, the underdog knocking the favourite out
of the contest.
In draft summit conclusions, subject to amendment on Friday,
the leaders were set to ask the EU's top four officials to
produce a detailed, time-bound roadmap in December leading to a
genuine economic and monetary union.
But markets may not wait that long.
Italy's benchmark borrowing costs hit six-month highs at
auction on Thursday, piling pressure on Monti to ease squeeze
concessions out of Germany.
Rome and Madrid have been pleading for help but received a
cool response from Berlin and other capitals so far.
The rescue funds will have a maximum firepower of 500
billion euros ($625 billion) once the ESM is fully stocked in
2013, minus 100 billion euros already earmarked to aid Spanish
The sources said the preferred creditor status of ESM loans
to Spain, which has spooked investors who fear they would be
last to be paid back in the event of a default, was likely to be
removed if Madrid issues covered bonds backed by state assets or
Italy and Spain would still have to request assistance,
which they have been loath to do, and would be subject to fiscal
policy conditions and international monitoring. But they might
not be required to do more in austerity and structural reforms
than they have already undertaken, the sources said.
"NEIN! NO! NON!"
Merkel was being urged at home to reject all efforts to make
Germany underwrite European borrowing or banks, which some of
her partners say may be the only way to save the single
"Nein! No! Non!" shouted a headline splashed across the
front page of the normally sober German business daily
Monti was also under mounting domestic pressure to achieve
results in reducing Rome's borrowing costs or risk seeing his
technocratic government fall within months as the parties that
support him jockey for position before an election due in 2013.
Van Rompuy and European Commission President Jose Manuel
Barroso have set long-term goals of creating a euro zone
treasury to issue joint bonds in the medium-term, and
establishing a banking union with central supervision, a joint
deposit guarantee and a resolution fund.
Merkel insists that fundamental reforms to give European
Union authorities power to override national budget and economic
policies must come before any further shared liability.
The euro hit a three-week low and world stocks fell as
investors bet that this latest summit would fail to produce
concrete measures to tackle the crisis, sending 10-year Spanish
government bond yields above the danger level of 7 percent.
France's Hollande advocates joint "eurobonds", which would
bring down borrowing costs for the weak because the pool of
guarantors would include the strongest - principally Germany.
Germany does not want to use its top credit rating to
support others unless they share control of tax and spending
powers first. Dutch premier Mark Rutte sided with Merkel in
arguing against any early move to share liability.
"It's crucial for us to avoid taking measures that would
ease pressure on southern Europe to reform," he said.
Finnish Europe Minister Alex Stubb told Reuters that Europe
should prepared to live in a state of crisis for the rest of the
decade. But he said a stronger and more resilient continent
would eventually emerge.
"It is an existential crisis, but it's probably the best
crisis we've had. It's forcing European leaders to take very
difficult decisions and as we all know very few difficult
decisions have been taken in a relaxed atmosphere," he said.