EU Begins Talks on Rescue as Germany Signals Flexibility

European finance chiefs start work today on a revamped debt-crisis-fighting strategy with Germany easing its opposition to an expanded arsenal and Portugal insisting it will get by without an aid package.

Germany, the leading power in the 17-nation euro region, is eyeing a March deadline for bolstering the 440 billion-euro ($589 billion) rescue fund, drawing up a permanent aid facility and rewriting the bloc’s budget-deficit rules.

A rising euro and successful bond auctions in Portugal, Spain and Italy offered a respite last week from market pressure for steps that go beyond the emergency aid program and the European Central Bank’s unprecedented bond purchases.

“European leaders need their backs to the wall in order to complete their monetary union,” Barry Eichengreen, an economics professor at the University of California at Berkeley, said on Bloomberg Television’s “Surveillance Midday” with Tom Keene. “I’m still convinced that’s what they’re about to do.”

Germany endorsed the need for a “comprehensive” approach to stemming the debt contagion amid concern that Greece and Ireland, recipients of 178 billion euros in European and International Monetary Fund loans last year, will struggle to nurse their economies back to health.

Still, German Finance Minister Wolfgang Schaeuble resisted an appeal by the European Commission, the bloc’s central regulator, for an upgraded anti-crisis toolbox to be unveiled as soon as a Feb. 4 summit of national leaders.

“We’re working on a comprehensive package so that we don’t find ourselves in a situation every few months in which we have to start discussions all over again,” Schaeuble said on Jan. 13. “A fundamental decision is to be taken in March.”

Meeting, Briefing

Euro-area finance ministers meet at 5 p.m. today in Brussels. Luxembourg Prime Minister Jean-Claude Juncker, the chairman, and European Union Economic and Monetary Commissioner Olli Rehn will brief the press in late evening.

Europe’s political sands are shifting even as Portuguese Prime Minister Jose Socrates says the country is beating deficit-cutting targets and doesn’t need a rescue. The ECB indicated that its focus may move from maintaining interest rates at a record-low 1 percent to combating inflation, which reached a two-year high of 2.2 percent in December.

Portugal gained breathing space with the sale of 599 million euros in 10-year bonds on Jan. 12, with borrowing costs dropping to 6.72 percent from 6.81 percent. For the week, the extra yield on Portuguese 10-year debt over German levels fell 45 basis points to 379 basis points. The euro rose 3.7 percent to $1.3388, the biggest weekly gain since May 2009.

‘Portuguese Saga’

Portugal will eventually be put under the umbrella of an EU-IMF bailout,” London-based Citigroup Inc. economists Juergen Michels and Giada Giani said in a research note. “Until the Portuguese saga around the access into a rescue package finds a resolution, market tensions are unlikely to abate.”

In response to ECB President Jean-Claude Trichet’s call for “quantitative and qualitative” improvements to the aid program, governments are considering putting more money on the table and using it more flexibly.

“It’s up to governments to assume their responsibilities,” Trichet said on France’s LCI television yesterday.

The need for a capital buffer to cinch a AAA rating cuts the lending capacity of the rescue fund to about 250 billion euros. Boosting its firepower needs to be part of a retooled approach, French Finance Minister Christine Lagarde said.

Lagarde said one option is to use the fund -- known as the European Financial Stability Facility -- to buy ailing countries’ bonds in the secondary market, easing strains on the ECB.

Weber’s Opposition
So far the central bank has spent 74 billion euros on bonds, in a policy that lacks the backing of Axel Weber, Germany’s representative on the ECB council and a potential successor to Trichet when his term ends in October.

“We need a global package, not a series of individual parcels,” Lagarde said on Jan. 14. “Just adding several hundred million won’t be enough.”
At meetings of lower-level officials last week, only the Netherlands spoke out against cutting the interest rate on emergency loans from the 5.8 percent charged to Ireland, two people familiar with the discussions said.
The rate is around 300 basis points higher than the EU’s cost of borrowing, a markup that was designed under German pressure to make EU aid a last-ditch option. EU policy makers view 50 to 100 basis points as a more suitable margin, a person familiar with the discussions said.

Debt Drag
Instead, with the EU predicting growth of only 0.9 percent in Ireland in 2011 and a contraction of 3 percent in Greece, the lending bill looms as an additional drag on the economy.
Aid talks are running in parallel with the drafting of new EU legislation to strengthen fiscal restraints that failed, for example, to sanction Greece for never meeting the euro area’s limit on deficits of 3 percent of gross domestic product.

Germany sent mixed signals on the new rules, first calling for “quasi-automatic” sanctions, then bowing to French insistence that fines on high-deficit countries be left up to a political vote.

EU governments plan to sign off on their version of the rules by the end of March. The next step will be a compromise with the European Parliament, which last week backed the ECB in seeking to make the sanctions as automatic as possible.

The proposals include a new standard for “prudent” budget policy, a nod toward Germany’s call for debt-limitation rules in national constitutions. France took a step in that direction last week when President Nicolas Sarkozy pressed ahead with a planned balanced-budget amendment.

To contact the reporter on this story: James G. Neuger in Brussels at jneuger@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net