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BW Businessworld

A Crucial Day For Europe

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Euro zone finance ministers are to agree on Tuesday the details of bolstering their bailout fund to help prevent contagion in bond markets, under pressure from the United States and ratings agencies to staunch a two-year-old debt crisis.

US President Barack Obama pressed European Union officials on Monday to act quickly and decisively to resolve their sovereign debt crisis, which the White House said was weighing on the American economy.

Underlining the threat to tottering European economies, ratings agency Moody's warned on Tuesday it could downgrade the subordinated debt of 87 banks across 15 countries on concerns that governments would be too cash-strapped to bail them out.

Rival Standard & Poor's could downgrade the outlook on France's top-level triple-A credit status with the next 10 days, signalling a possible ratings cuts, a newspaper reported. The news briefly hit the euro.

White House spokesman Jay Carney said Obama's message, delivered to top EU officials behind closed doors in Washington, was that: "Europe needs to take decisive action, conclusive action to handle this problem, and that it has the capacity to do so."

Tuesday's meeting of the Eurogroup, which brings together finance ministers from the 17 euro zone members, was set to fix details of leveraging the European Financial Stability Fund (EFSF) so it can help Italy or Spain should they need aid.

They are also likely to approve the next tranche of emergency loans for Greece and Ireland.

Documents obtained by Reuters on Sunday showed the detailed guidelines for the EFSF were ready for approval, opening the way for new operations and multiplying the fund's effective size.

The documents spell out rules for EFSF intervention on the primary and secondary bond markets, for extending precautionary credit lines to governments, leveraging its firepower and its investment and funding strategies.

"I would expect we will be in a position to approve the guidelines at a political level," a euro zone official involved in the preparations for the ministers' meeting said.

The EFSF guidelines will clear the way for the 440 billion euro facility to attract cash from private and public investors to its co-investment funds in coming weeks.

ECB Role
The European Central Bank (ECB), which is now buying bonds of Spain and Italy on the market to prevent their borrowing costs running out of control, has been urging euro zone ministers to finalise the technical work on the EFSF quickly.

Officials have told Reuters that the leveraging mechanisms could become operational in January, but that may be too late.

With Germany rigidly opposed to the idea of the ECB providing liquidity to the EFSF or acting as a lender of last resort, the euro zone needs a way of calming markets, where yields on Spanish, Italian and French government benchmark bonds have all been pushed to euro lifetime highs.

The OECD rich nations' economic think-tank said on Monday the ECB should cut interest rates and abandon its reluctance to step up purchases of government bonds in order to restore confidence in the euro area.

The ECB shows no sign of doing so yet. It bought 8.5 billion euros of euro-zone government debt in the latest week, at a time of acute turmoil, in line with its previous activity but well short of what economists say is necessary to turn market sentiment around.

Sources have said the Obama administration has also urged Europe to allow the ECB to act as lender of last resort as the U.S. Federal Reserve does.

Franco-German Plan
Germany and France stepped up a drive on Monday for coercive powers to reject euro zone members' budgets that breach EU rules, alarming some smaller nations who fear the plans by-pass mechanisms for ensuring equal treatment.

Berlin and Paris aim to outline proposals for a fiscal union before an EU summit on Dec 9 increasingly seen by investors as possibly the last chance to avert a breakdown of the single currency area.

"We are working intensively for the creation of a Stability Union," the German Finance Ministry said in a statement. "That is what we want to secure through treaty changes, in which we propose that the budgets of member states must observe debt limits."

Rumours about the threat to France's credit rating, which have circulated for several months, illustrate how the crisis has moved inexorably from indebted peripheral nations such as Greece and Portugal to the heart of Europe.

Economic and Financial daily La Tribune reported on its website that S&P's was preparing to change its outlook on France's sovereign rating from "stable" to "negative".

"It could happen within a week, perhaps 10 days," La Tribune quoted a source as saying.

The news coincided with the warning on subordinated debt from Moody's, which said the greatest number of ratings to be reviewed were in Spain, Italy, Austria and France, and knocked the euro a third of a cent before the currency recovered.

"Moody's believes that systemic support for subordinated debt in Europe is becoming ever more unpredictable, due to a combination of anticipated changes in policy and financial constraints," the agency said in a report.

Holders of subordinated debt are further back in the queue than owners of senior debt when it comes to a claim on a bank's assets, thus making it a riskier class of debt.

Mario Monti, Italy's prime minister and finance minister, will attend Tuesday's meeting to explain the reforms Italy plans to undertake to regain the confidence of markets.

Saddled with debt equal to 120 per cent of GDP and soaring borrowing costs, Italy has been battling to avoid financial disaster, which analysts say would endanger the whole euro zone.

In a sign of intense market stress, short-term Italian yields last week climbed above those of longer-dated issues. Both are higher than the 7 percent level widely seen as unsustainable for the country's public finances.

The funding pressure is set to be underlined on Tuesday, when investors are expected to demand more than 7 per cent at auction to buy three- and 10-year Italian debt.