Irish Times

A new clash over the European Central Bank (ECB) and political turmoil in Italy kept the euro zone on edge today on the eve of a summit meant to confront the currency bloc’s worsening sovereign debt crisis.

Just 24 hours before European leaders are due to adopt a plan to reduce Greece’s debt burden, fortify European banks to withstand bond losses, and scale up the euro zone rescue fund to prevent market contagion, disputes raged in Rome and Berlin.

There was also no sign of a deal in negotiations to reduce Greece’s debt to private sector bondholders, and uncertainties remained over the size of a planned bank recapitalisation and the scope of leveraging of the rescue fund.

Chancellor Angela Merkel, fighting to secure parliamentary backing for euro zone rescue measures, said Germany opposed a phrase in the draft summit conclusions urging the ECB to go on buying troubled states’ bonds.

The euro slipped and safe-haven German bond futures rose after Ms Merkel’s comments since continued ECB support is widely seen as crucial to stabilising the markets.

In Rome, Prime Minister Silvio Berlusconi’s faction-ridden cabinet failed to agree at an emergency session late yesterday on raising the retirement age, a key economic reform demanded by Italy’s EU partners as a condition for supporting its bonds.

Mr Berlusconi responded truculently to public pressure from French President Nicolas Sarkozy and Ms Merkel at an EU meeting on Sunday, saying that no one could teach Italy lessons.

The European Commission said the aim was not to humiliate Italy but to ensure that a member state meets its commitments on budget discipline and economic co-ordination.

“It’s not about challenging sovereignty, it’s not about lecturing, it’s not about humiliating,” said the Commission spokesman on economic issues, Amadeu Altafaj. “We have 27 democratically elected governments, which have agreed on reinforcing surveillance and on having a higher degree of coordination of their economic policies. It makes sense. It’s one of the main lessons of the crisis.”

The 17-nation euro zone is set to shore up its bailout fund to contain the debt turmoil that threatens to engulf more countries across Europe. German politicians said the plan could boost the fund’s lending capacity to more than €1 trillion.

A document shows the currency zone wants to boost the €440 billion bailout fund by offering sovereign bond buyers an insurance against possible losses and by attracting capital from private investors and sovereign wealth funds.

Euro zone governments hope that the enhanced European Financial Stability Fund, or EFSF, will be able to protect countries such as Italy and Spain from being engulfed in the debt crisis. To do that, however, it needs to be bigger or see its lending powers magnified.

Governments are demanding that banks and insurers accept a 60 percent “haircut” as part of a second rescue package to make Athens’ debt mountain, set to reach 160 per cent of economic output this year, more sustainable.

Bank negotiators have offered a 40 per cent write-down and warned that forcing them into deeper losses would amount to a forced default with what banks say will be devastating consequences for the European financial system.

EU diplomats said the outcome of the game of chicken between governments and banks was uncertain, but some forecast a last-minute deal on a 50 per cent write-down.

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