Germany lowered expectations of a breakthrough in the Eurozone's sovereign debt crisis next weekend, saying Sunday's EU summit will not produce a final solution, and kept up pressure on banks to accept bigger writedowns on Greek debt.
Financial markets have risen in the last week on hopes that the 27 European Union leaders will agree on a comprehensive plan to draw a line under the two-year-old crisis, which is weighing on the world economy.
But German Finance Minister Wolfgang Schaeuble said in a speech in Duesseldorf on Monday that while European governments would adopt a five-point platform to address the turmoil, it was wrong to expect a definitive solution at the summit.
Schaeuble said the plan would have to include a reduction in Greece's debt mountain. He repeated at the weekend that private bondholders would have to accept steeper voluntary write-downs on their Greek holdings than the 21 percent agreed last July.
A lead negotiator for the banks said this could only happen if policymakers addressed the full range of sovereign debt issues in Europe. Charles Dallara of the Institute of International Finance (IIF) declined comment on reports that the private sector might have to take a 50 percent loss.
On Monday the euro rose to a new one-month high against the dollar and European shares hit a 10-week peak on optimism about the October 23 summit, which G20 finance chiefs called a decisive moment. But European stocks gave back some gains and German bonds rose after Schaeuble's remarks.
Meeting those high expectations will be difficult. Euro zone leaders are in a race against time to convince banks to accept voluntary writedowns of up to 50 percent on their Greek debt. They are also trying to agree on a blueprint for recapitalizing financial institutions at risk from the deepening crisis.
Determining how the writedowns will be applied and the source of funds to recapitalize the banks will require arduous negotiations between now and the deadlines the EU has set for itself, said Dan Morris, global strategist at J.P. Morgan Asset Management.
We remain optimistic an agreement will be found but returns have been so strong over the last few weeks there is a risk of disappointment if it takes longer to work out the details than investors expect.
Pre-summit talks are taking place amid renewed social unrest in Greece. Much of the country is expected to be shut down by a 48-hour strike that will peak on Thursday, just as parliament votes on controversial new austerity measures.
Merkel's spokesman said the government was working intensively to define how German banks would participate in a second rescue package for Greece and how to make best use of the bloc's 440 billion euro rescue fund, the European Financial Stability Facility (EFSF).
Leaders hoped to take a big step forward in addressing the crisis, he said, warning that expectations for the summit had gotten out of hand.
The chancellor has pointed out that the dreams building up that this package will mean everything will be solved and over by Monday cannot be fulfilled, Steffen Seibert said.
BANKS PUSH BACK
Dallara, managing director of the IIF, told Reuters that private holders of Greek bonds were prepared to discuss changes in how they might participate in future Greek debt relief.
EU officials say the bankers have little choice, since the alternative would be a disorderly default that would trigger wider financial market chaos and bigger losses.
But in a sign of growing frustration with policymakers, who have changed their crisis strategy repeatedly as Greece's woes have deepened, Dallara said a broader discussion was needed.
Privately, bankers say addressing Greece's woes alone will accomplish little. They are pushing policymakers to come up with a stronger plan for addressing the woes of the entire euro zone.
One solution under discussion is leveraging the EFSF to give it more firepower, but it is unclear whether a solution can be found that satisfies Germany and other northern European members of the currency bloc.
If the official community is interested in asking the private sector to take another look at Greece then it will have to be only as part of a broader process of addressing the full range of sovereign debt issues in Europe, Dallara told Reuters.
And it will have to be on the basis of an open and transparent discussion about the Greek economic adjustment program and the associated issues of debt sustainability.
Greece's overall debt mountain is forecast to climb to 357 billion euros this year, or 162 percent of annual economic output -- a level economists agree is unsustainable.
How to recapitalize banks is another source of conflict. The European Banking Authority (EBA), which is assessing bank capital needs, is expected to mark down the value of their sovereign debt holdings and require a 9 percent core Tier 1 capital ratio.
This would force banks to raise billions of euros. Leading German and French banks have said they will resist forced recapitalizations, but the French government made clear on Monday that this is what policymakers wanted.
French banks will be recapitalized even though they are solid because we are in a climate of extreme nervousness, extreme tension and lack of confidence so we must strengthen all the banks, French government spokeswoman Valerie Pecresse said on French radio.
We are going toward a collective European solution, she added. We will ask all European banks to have 9 percent capital ratios by 2013 to be more solid to face risk.
The 2013 deadline Pecresse mentioned was much later than EU officials have suggested. They want banks to be given three to six months to reach the target.