European Union leaders meet on Thursday to try to agree the next steps in tackling a year-long debt crisis that has consumed Greece and Ireland and threatens to spread to Portugal and Spain.
After months of battling to put out fires, including a 110 billion euro bailout for Athens and an 85 billion euro aid package for Dublin, EU leaders will discuss changing the EU's treaty to create a permanent crisis-resolution mechanism from 2013, and may look at enlarging their existing crisis fund.
The two-day summit comes as market pressure on the sovereign debt of peripheral euro zone states has fallen marginally before year-end, but EU officials are conscious that any failure to take decisive action could be interpreted as weakness, with the threat of further bond market fallout early next year.
Ratings agency Moody's warned Spain on Wednesday that its debt could be downgraded, and Portugal took steps to revive its economy and bolster its finances, hoping to stave off renewed market pressure that could force it into an EU bailout.
Moody's said it was concerned about Spain's high debt funding needs, its heavily indebted banks and its regional finances, but it did not expect Madrid would have to follow Greece and Ireland in seeking EU assistance.
The Portuguese government announced moves to cut red tape and boost growth, and said it would soon adopt quarterly fiscal targets. Both Spain and Portugal have come under intense pressure and are facing funding crunches next year.
TREATY CHANGES, ECB CAPITAL
As well as approving a change to the EU's treaty demanded by Germany to create a permanent system for handling crises from mid-2013, EU leaders will discuss how they can improve the current temporary financial safety net -- a 750 billion euro ($1 trillion) joint EU/IMF loan facility.
One possibility is to increase the size of the fund, while another would involve making it more flexible in terms of the loans it can make, including the possibility of credit lines.
Belgian Finance Minister Didier Reynders said the EU's portion, 440 billion euros, could potentially be doubled to fend off the threat of renewed market pressure on Portugal and Spain, and Spain's economy minister backed the idea of a larger fund.
The EU's leading powers, Germany and France, say less than 10 percent of the rescue funds have been committed so far, so there is no urgent need to increase the money available.
German Chancellor Angela Merkel said no country in Europe would be left on its own, and reiterated that the euro was a strong currency that would be defended to the hilt.
We know that the euro is our collective destiny, and Europe is our collective future, she said on Wednesday. Nobody in Europe will be abandoned. Europe will succeed together.
European Commission President Jose Manuel Barroso urged leaders to act fast to reach a consensus at the summit.
TACKLE THE CENTRAL ISSUE
EU diplomats have worked to clear the decks of outstanding issues before the summit so that discussions can focus on crisis resolution. Officials fear financial markets may seize on a lack of action when trading picks up again next year.
The European Central Bank holds the second day of a regular, non-rate setting meeting on Thursday, when it is expected to agree to ask euro zone member states for more capital, a move to lower its risk profile as it helps tackle the debt crisis.
That issue may be discussed among EU leaders on Thursday, when they will be joined for dinner by ECB President Jean-Claude Trichet. The ECB has come under pressure to step up its bond-buying program to help the likes of Portugal, which is struggling to fund itself on the market.
As well as fears about the debt situation in Portugal and Spain, which has approximately 275 billion euros of sovereign and bank debt expiring in 2011, there are increasing worries about other euro zone member states.
Belgium had the outlook on its sovereign debt lowered by Standard & Poor's on Tuesday, with the threat of a downgrade within six months if it fails to sort out a political impasse.
Top EU officials, including Luxembourg Prime Minister Jean-Claude Juncker and the Italian finance minister, have called for the euro zone to consider issuing collective treasury bonds, or e-bonds, which would effectively mean the 16 euro zone countries sharing credit risk and debt issuance.
Germany opposes the proposal, which would expose its credit risk to the influence of riskier peripheral euro zone countries such as Portugal and Greece. The issue may be raised at the EU summit, but no decisions are expected.
(Editing by Jon Boyle)