The European Central Bank acted to soften a looming recession and avert a credit crunch in the debt-plagued euro zone by cutting interest rates on Thursday as European Union leaders prepared for a crucial summit.
The ECB cut its main rate by a quarter-point to a record low 1.0 percent as anxiety over the worsening sovereign debt crisis drowned out concern about above-target inflation.
ECB President Mario Draghi was expected to announce further action to support teetering banks with longer term credit at a news conference at 1:30 p.m. British time. He has signalled the central bank may act more decisively if an EU summit on Friday agrees to move towards fiscal union in the euro area.
European Commission Jose Manuel Barroso appealed to European leaders holding their eighth crisis summit of the year to put aside sharp differences to support their common currency.
The summit that we are going to tonight in Brussels is indeed a crucial one, Barroso said at a meeting of European conservative party leaders in the French port city of Marseille, using words reminiscent of late U.S. President John F. Kennedy.
What I expect from all heads of governments is that they don't come saying what they cannot do but what they will do for Europe. All the world is watching us and what the world expects from us is not more national problems but European solutions.
France and Germany planned to use the Marseille meeting to lobby for their plan to amend the European Union treaty to toughen budget discipline, which they want to have ready by March. But several countries are sceptical.
The often contradictory views were illustrated by two comments that came within a few hours of one another. France's Europe minister said the fate of the euro was at stake.
What that means ... is that the euro can explode and Europe come apart. That would be a catastrophe not only for Europe and France but for the world, Jean Leonetti told Canal+ television.
The chairman of euro area finance ministers said the 17-nation currency was not at risk.
The euro gained on currency markets after the ECB decision but European shares pared gains in thin trading with investors sidelined by uncertainty over the summit outcome.
A Reuters poll of economists found that while 33 out of 57 believe the euro zone will probably survive in its current form, 38 of those questioned expect this week's summit will fail to deliver a decisive solution to the debt crisis.
U.S. Treasury Secretary Timothy Geithner, winding up a visit to Europe to urge decisive action, praised Italy's new austerity budget and reform plans and said the world could be encouraged by the euro zone's progress in the last few weeks.
It was essential for European leaders to strengthen their financial firewall to give economic reforms a chance to work, he said after talks with new Italian Prime Minister Mario Monti in Milan.
Ratings agency Standard & Poor's has ramped up pressure by threatening a mass downgrade of euro-zone sovereign ratings.
It extended that threat on Wednesday to include the European Union itself, which has had a top-notch AAA rating since the mid-1970s, and large euro-zone banks.
In one glimmer of positive news for stressed euro zone countries, two big financial clearing houses cut the cost of using Italian bonds to raise funds following some easing in the country's bond yields.
In moves to strengthen the euro zone's financial firewall, euro zone officials said the summit was likely to decide to bring forward the launch date of a permanent bailout fund to 2012 from mid-2013 and were close to agreement for their central banks to lend 150 billion euros (127.9 billion pounds) to the IMF for firefighting.
However, a proposal to give the permanent European Stability Mechanism the right to act like a bank with access to ECB funding was off the table due to German opposition, one euro zone source said amid preparatory negotiations.
French President Nicolas Sarkozy and German Chancellor Angela Merkel had a chance to rally many European leaders behind their plan at a congress of the conservative European People's Party on Thursday in Marseille.
But the EU remains divided over the need for treaty change. Summit chairman Herman Van Rompuy is urging leaders to avoid a laborious full overhaul that could take up to two years and face uncertain ratification. He wants them instead to slip stricter budget enforcement through in a protocol to existing treaties.
This infuriated Merkel and was one reason behind a gloomy briefing by a senior German official on Wednesday, who dampened hopes for a breakthrough and said some leaders and institutions still didn't understand the severity of the crisis.
If all 27 EU states do not support more fiscal union by adapting the existing Lisbon treaty, which took eight years to negotiate, then Sarkozy and Merkel want the 17 euro zone countries to go ahead alone with more integration.
Swedish Prime Minister Fredrik Reinfeldt, speaking for a non-euro state, said: We respect that the euro zone wants their own meetings and take part of the responsibility on their own ... But we want to stick with the 27 concept of course because all of us are members of the European Union and we want to have our influence. We want to keep the European project together.
Sarkozy and Merkel are both due to hold bilateral meetings later with incoming Spanish Prime Minister Mariano Rajoy before they head to Brussels.
We need more binding and more ambitious rules and commitments for the euro area member states, Sarkozy and Merkel wrote in a letter to European Council President Van Rompuy, who has made his own proposals for tackling the crisis.
The Franco-German plan would slap automatic penalties on countries that overshoot deficit targets and make countries anchor a balanced budget rule in their constitutions. The sanctions could be stopped only if three quarters of euro zone countries are against them.
Not all euro zone countries are comfortable with all the French and German proposals, with Finland opposed to their call for majority votes on major policy decisions.
Finland's view is very clear, our stance is that unanimity is required in decision-making ... and that is the view Finland will promote going forward as well, Finnish Finance Minister Jutta Urpilainen told reporters on Wednesday in Helsinki.
Finland recently held up approval of an expansion of the EU's rescue fund to demand collateral on loans to Greece, one of three euro zone states to receive an EU/IMF bailout.
With financial market doubts hanging over the euro zone's temporary EFSF financial rescue fund, many economists say that the most effective way of getting a grip on the crisis would be for the ECB to buy euro zone government bonds more aggressively.
But an ECB source said any action on that front would have to await the outcome of Friday's EU summit.
(Additional reporting by Leigh Thomas and Brian Love in Paris, Sakari Suoninen in Frankfurt, Jan Strupczewski in Brussels, and Terhi Kinnunen in Helsinki; Writing by Paul Taylor; Edited by Janet McBride/Mike Peacock)