Two leading international financial institutions faulted Germany for aggravating the euro zone crisis by spooking debt markets, but Berlin seems set to get its way at this week's European Union summit.
EU leaders are not expected to announce new measures to ease market concerns about the region's debt, though one source said intense efforts were being made behind the scenes to find ways to inoculate Spain early next year against the threat of contagion.
The Bank for International Settlements (BIS) and the head of the European Investment Bank (EIB) both said German Chancellor Angela Merkel's drive to make private bondholders share losses in any future euro zone sovereign default had intensified the crisis.
The surge in sovereign credit spreads began on October 18, when the French and German governments agreed to take steps that would make it possible to impose haircuts on bonds should a government not be able to service its debt, the Basel-based BIS said in its quarterly review.
EIB president Philippe Maystadt said Merkel was absolutely right to demand a private sector contribution to financial rescues after an emergency safety net expires in 2013, but the way it was presented created total confusion.
EU leaders are set to approve a two-sentence amendment to the 27-nation bloc's Lisbon treaty on Thursday and Friday that would create a permanent European Stabilization Mechanism to lend to distressed member states on strict conditions.
They will also endorse a statement by euro zone finance ministers specifying that private sector investors will be expected to contribute, on a case-by-case basis, in any sovereign debt restructuring after 2013.
But at the insistence of Berlin and Paris, they are unlikely to increase the existing rescue fund or to take any action on a proposal for common European bonds to help resolve the crisis.
EU sources said euro zone finance ministers would work in January on a more systemic response to the crisis, which has already driven Greece and Ireland to require EU/IMF bailouts and threatens to spread to Portugal, Spain and even Italy.
NO ACTION ON E-BONDS
Euro zone bond markets have entered an end-of-year lull as investors close their books, with yield spreads on peripheral debt just a touch wider on Monday, but EU officials are preparing for another potential wave of selling early in the new year.
A German government spokesman said indications were that the summit would not take up a proposal to introduce communal euro zone 'E-bonds' made by Jean-Claude Juncker -- veteran chairman of the single currency area's finance ministers -- and Italian Economy Minister Giulio Tremonti.
The spokesman also told a news briefing he was not aware that any examination of an extension of the existing European Financial Stability Facility was under way, as reported by the Financial Times.
The newspaper said European officials were considering options such as using the EFSF to buy bonds of distressed states without resorting to fully fledged bailouts.
However, the German spokesman said that would be a bad idea and a senior euro zone source told Reuters it was not being seriously considered.
Another EU source said intensive work was going on behind the scenes on ways to make European crisis management instruments more flexible and better able to help countries before they become shut out of credit markets.
The crucial aim was to ringfence Spain, the fourth largest euro zone economy, against debt market contagion. Madrid was taking energetic measures to avoid being sucked down with the crisis, the source said.
Experts are also studying how to access the full 440 billion euros ($580 billion) in the emergency mechanism if necessary, despite pledges to maintain a cash buffer given to secure a top notch AAA credit rating for the EFSF, the source added.
Luxembourg Foreign Minister Jean Asselborn said the 'E-bond' proposal, designed to reduce the borrowing costs of troubled euro zone states and prevent speculation against their debt, had been excluded from the EU summit agenda.
I hope we will never need to talk about euro bonds again, he said. If we manage to secure the stability of the euro by making clear decisions this week, and I'm sure that the European Union is capable of doing this... then I think we can do it, Asselborn told Deutschlandfunk radio.
The Organization for Economic Cooperation and Development forecast a subdued economic recovery for the euro zone due to deficit-cutting austerity measures, but endorsed the EU's drive to give budget consolidation priority over boosting growth.
Economists have voiced concern that pay and public spending cuts, combined with tax increases prescribed to bring down excessive deficits in Greece, Ireland, Spain and Portugal will prolong recession, hitting revenues and making the required fiscal adjustment even harder.
But the OECD said in a report that euro zone countries needed the fiscal tightening even though it was likely to dampen growth in the near term.
(Additional reporting by Erik Kirschbaum and Annike Breidthardt in Berlin, Sakari Suoninen in Frankfurt; writing by Paul Taylor; editing by John Stonestreet)