Merkel stands ground ahead of euro summit

BERLIN/BRUSSELS (Reuters) - EU leaders arrived for a Brussels summit on Thursday more openly divided than at any time since the euro crisis began, with Germany's Chancellor Angela Merkel showing no sign of relenting in her refusal to back other countries' debts.

Merkel is being urged at home to hang tough and reject all efforts to make Germany underwrite European partners' borrowing or banks, while her European Union partners say that may be the only way to save the single currency.

"Nein! No! Non!" shouted a headline splashed across the front page of the normally sober German business daily Handelsblatt, with a commentary by its editor-in-chief saying Merkel must remain firm at the two-day summit.

Spain and Italy, the latest euro zone countries in financial markets' firing line, are pleading for emergency action to bring down their spiraling borrowing costs before they are forced out of the bond market. They want the euro zone's rescue funds or the European Central Bank to intervene fast.

A senior German government source, briefing reporters in Berlin before the summit, due to start at 0900 EDT, played down the leap in Spanish and Italian borrowing costs.

"We would warn against exaggerated panic-making," he said.

European Council President Herman Van Rompuy and European Commission President Jose Manuel Barroso proposed in a report 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.

"Now she must explain to our friends at the summit that it would help no one if Germany lavishly handed out the fruit of its labor. It is even the other way around: 'yes' to Europe means 'no' to Barroso's ideas," Handelsblatt's Gabor Steingart wrote.

His comment reflected widespread public views in Germany, which has enjoyed an export boom while Greece, Ireland and Portugal and now Spain and Cyprus have needed bailouts. The economic crisis is only just starting to pinch in Germany, where growth is slowing and unemployment crept up unseasonally in June.

Hans-Werner Sinn, head of the Ifo economic research institute and a leading Eurosceptic, said in a working paper: "Had we known 20 years ago what difficulties the euro zone would be mired in today, and what pressures we would face, Germany would never in its life have agreed to the euro, at least not with all those who are members today."

TURMOIL

The meeting is the 20th summit of leaders of the 27 EU states since the crisis erupted in early 2010, giving them a reputation for failing to match their talk with the sort of decisive action needed to resolve it.

The euro hit a three-week low and European shares 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.

Italy had to pay its highest yield since December of 6.19 percent to sell 10-year debt on Thursday, helped by domestic demand and a smaller-than-average sale.

Many international investors have deserted Spanish and Italian debt, pushing yields to levels that Madrid at least cannot afford for long as it tries to save banks ravaged by a property market collapse and rein in an overshooting deficit.

European Economic and Monetary Affairs Commissioner Olli Rehn said the summit would work on unspecified "short-term measures" to stabilize markets. Merkel has brushed aside demands from Rome and Madrid for rapid measures to support their bonds.

French President Francois Hollande is championing joint "eurobonds", which would bring down borrowing costs for the weaker euro zone countries because the pool of guarantors would include the strongest - principally Germany.

EU leaders agree in theory that addressing the euro zone's imbalances must involve "more Europe" - greater coordination of financial affairs among countries that share the common currency. But they disagree sharply about how to get there.

France's Hollande argues that Europe must show greater "solidarity" - support for weaker members - before it asks them to give up independent policy powers. Germany, by contrast, does not want to use its credit rating to support others unless they share control of tax and spending powers first.

Finnish Prime Minister Jyrki Katainen, one of a handful of Merkel allies from north European creditor states, said on arrival in Brussels: "We cannot create a Europe which is based on mutualised liabilities or new structures just for having new payers for the current bill."

Hollande and Merkel met in Paris on Wednesday evening to try to narrow their differences.

While they agreed on a package of measures to promote growth trumpeted as being worth 130 billion euros - the first item on Thursday's summit agenda - there was little sign of a meeting of minds on the thornier crisis-resolution issues.

ECB governing council member Christian Noyer of France told Le Monde that Europe had reached a crossroads where monetary union was no longer sufficient and a step towards federalism was needed, including closer budgetary union, adding he was "very open" to eventually pooling debt in a later stage.

Austrian Chancellor Werner Faymann said the 17-nation currency bloc's permanent rescue fund, the European Stability Mechanism (ESM), due to start operating next month, should be turned into a bank and allowed to borrow from the ECB, which could quadruple its 500 billion euro ($625 billion) warchest.

"We need a banking license for the ESM, a debt reduction fund, strict rules for banks with more intervention rights for supervision," he told Austria's Kleine Zeitung daily.

That backed proposals by Italian Prime Minister Mario Monti to leverage up the rescue funds to underpin troubled countries' bonds. But ECB chief economist Peter Praet said he was "very skeptical" of Monti's idea, which would greatly increase the central bank's exposure.

"The funds would guarantee part of the risks, and we would take the rest on our books," Praet told Financial Times Deutschland.

The senior German source said the EU already had instruments to handle all crisis scenarios, and Berlin was skeptical about developing yet another tool to solve Italy's problem.

Speaking in parliament on Wednesday, Merkel said she considered joint euro bonds and bank deposit guarantees illegal, economically wrong and politically counterproductive. Even Europe's strongest economy must not be overburdened, she said.

Rehn said euro zone leaders would work at their own mini-summit on Friday afternoon on steps to relieve market pressure on countries at risk.

"We are working with euro area member states in order to enable convincing decisions for the short-term stabilization of the financial markets, especially bond markets of euro area member states under particular market pressure," he said.

Spanish Prime Minister Mariano Rajoy said he would ask other EU leaders to allow the bloc's bailout funds or the European Central Bank to stabilize financial markets.

"The most urgent issue is the one of financing. We can't keep funding ourselves for a long time at the prices we're currently funding ourselves," he told parliament.

(Additional reporting by Gernot Heller in Berlin, Lorraine Turner in Dublin, Julien Toyer, Jan Strupczewski and Luke Baker in Brussels, Georgina Prodhan in Vienna, Catherine Bremer and Vicky Buffery in Paris; Writing by Paul Taylor; Editing by Michael Roddy)

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