Ahead of summit aimed at saving euro, ECB slashes interest rates

European leaders preparing for a summit billed as the last, best chance to save the euro sniped at one ­another behind closed doors Wednesday as they argued about how best to bind themselves together to ensure the future of their currency.

To quell a crisis that is threatening the global economy, Germany and France, the two largest nations in the euro zone, are calling for an agreement by Friday to rewrite European Union treaties to automatically punish overspending governments. The plan they are laying out would squeeze a process normally taking years, if not decades, into the next several months.

Meanwhile, the European Central Bank on Thursday slashed interest rates for the second month in a row, a dramatic attempt to keep the continent from sliding into recession.

As the summit drew closer, friction was building, with the Germans blasting an alternative proposal being floated by Herman van Rompuy, the head of the European Council of heads of state, and drafted with the input of smaller E.U. nations. The plan envisions a potentially larger bailout fund for nations in crisis and suggests a more tempered approach to fiscal discipline that could win approval faster and more easily.

European diplomats were warning that the summit could push beyond the Friday deadline in the quest for a workable deal, and a top official in Berlin said some European leaders still failed to grasp the “seriousness of the situation.”

It set the stage for what could be a tense summit in Brussels, where leaders were set to begin hashing out an agreement Thursday night. For Europe, a signed pact would begin to answer a pivotal question: Will the region pull closer together, repairing some of the fundamental flaws of the euro union, or risk the currency zone breaking apart? For the rest of the world, however, the summit is revolving around a far more basic question: This time, will European leaders finally get it right?

Thus far, every attempt by European leaders to address a debt crisis that started in Greece two years ago has failed, allowing the region’s turbulence to spread to the larger economies of Italy, Spain and even France. Although the pact being worked out could be the most ambitious attempt yet to address the continent’s troubles, the verdict is out on whether it will be enough.

The credit ratings agency Standard and Poor’s added one more reason for Europe to act decisively Thursday when it warned it may downgrade the AAA rating of the 27-nation European Union. The announcement of a so-called “creditwatch negative” follows a warning a few days ago to downgrade several eurozone countries, including Germany and France.

Europe’s crisis now is as much political as economic. It stems from a legacy of overspending and overborrowing, but in a region of vast financial means, it also reflects a lack of investor faith in the will of financially solid nations such as Germany to unite behind their troubled neighbors to shore up the currency union.

Acknowledging that Europe’s leaders have been slow to address the crisis, French President Nicolas Sarkozy conceded this week that the clock was running out. “We don’t have time,” he said. “We are conscious of the gravity of the situation.”

In the classic tradition of the European Union, the deal hatched in Brussels could be complicated, bureaucratic and fraught with obstacles even after an agreement is reached. For instance, some nations, such as Ireland, where polls show the public is opposed to treaty changes, may need to hold national referendums if E.U. treaties are altered.

If agreed to, the new pact could institutionalize austerity in Europe, triggering automatic sanctions on big-spending governments and forcing countries to forfeit a degree of national sovereignty. Expectations that the summit will succeed have eased market pressures on troubled nations such as Italy and Spain, meaning failure could trigger a severe investor reaction that again upends global markets.

It could be a nail-biter. There are still marked disagreements, for example, over just how automatic the penalties for overspending should be and how deeply they should be enshrined in the region’s laws.

Leaders appeared to be coalescing, however, around a key promise to bond investors that their money would be safe in the event that another country in the region requires a bailout, as well as a call for the Washington-based International Monetary Fund to play a bigger role in the crisis.

ECB firepower

Yet despite the focus on the summit, the long-term changes envisioned for an agreement would do little to combat the crisis immediately.

Rather, investors hope that any deal on austerity this week will finally persuade the European Central Bank, which has held back from doing more to contain the crisis for fear of dulling the incentive for big fiscal changes, to finally take the safety off and unleash more financial firepower.

Such a move is viewed as the best, and perhaps only, immediate solution to the crisis, but it has so far only been hinted at in cautious language by European leaders and may not be spelled out directly in any deal reached here.

Along with German Chancellor Angela Merkel, Sarkozy sent a letter to van Rompuy outlining the Franco-German vision of a deal on Wednesday. That plan called for treaty changes to set a limit for budget deficits at 3 percent of gross domestic product and a cap on debt of 60 percent of GDP — effectively mandating good fiscal governance. Violators would be flagged by the European Court of Justice and would face penalties from a council of European leaders.

But smaller nations in the region, feeling increasingly bullied by Berlin and Paris, appear to be finding more solace in the alternative plan drafted by van Rompuy, an austerity pact that might not require as laborious a process to enact as the Franco-German plan.

The Germans, in particular, strenuously rejected the van Rompuy plan. One top German official, speaking on the condition of anonymity at a background briefing before he departed for the summit, called it a “typical Brussels bag of tricks,” saying that it resorted to bureaucratic sleight of hand rather than something strong enough to convince markets that Europe is serious about fixing its problems. The official said he was “pessimistic” about an agreement being reached by Friday and added that he had kept his weekend plans open.

“We’ll get the crucial result before Christmas . . . even if it takes several rounds of negotiations,” the German official said. He added that Germany would be open to a treaty covering just the 17 countries that share the euro, and any others that wanted to join in, if it appears impossible to get all 27 countries in the European Union to agree.

Permanent bailout fund

Some diplomats were pushing an idea that a $680 billion permanent European bailout fund, scheduled to be launched by 2013, should not only be moved up but also be boosted to more than $1 trillion by adding the unspent cash from a temporary rescue fund that was already set up to deal with the crisis.

That larger fund, they reasoned, could then be turned into a bank, allowing it to borrow even more cash from the European Central Bank. But German officials called such ideas “gimmicks” and immediately declared their opposition to both.

Germany’s renewed pressure could be in part an exercise in brinkmanship, intended to push dawdling countries and officials to get on board in advance of the summit. As recently as a few days ago, German officials sounded privately optimistic about the prospects of an initial agreement this weekend, followed by negotiations on the specifics that Sarkozy said on Monday could last until March.

Yet experts say it would be wrong to minimize the kind of agreement that could come out of the summit. If common ground is reached, as most observers predict, it could set the region down a far faster path toward integration — considered essential for the survival of the euro — that would have been unthinkable before the onset of a potentially catastrophic debt crisis.

“If they are able to agree to it, this is very significant,” said Robin Niblett, director of Chatham House, a London-based think tank. “ For the first time, really, it could mean European Union intervention in the economies of its member states.”

Birnbaum reported from Berlin.

Anthony Faiola is The Post's Berlin bureau chief. Faiola joined the Post in 1994, since then reporting for the paper from six continents and serving as bureau chief in Tokyo, Buenos Aires, New York and London.
Michael Birnbaum is The Post’s Moscow bureau chief. He previously served as the Berlin correspondent and an education reporter.
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